With Goldman Sachs and Morgan Stanley becoming commercial banks, and the other three big investment banks/brokerage houses being acquired by commercial banks, politicians and the press won't have Wall Street to kick around anymore. Headlines now shout about a $700 billion "Bailout for Wall Street." Yet strictly speaking, Wall Street as we knew it no longer exists.

The conversion or absorption of all five of Wall Street's big investment banks into commercial banks raises several intriguing issues.

First of all, the financial storms over the past year have -- before last week -- been largely confined to securities markets and to interbank loans among commercial and investment banks. Bank loans to commercial and industrial business, real estate and consumers continued to expand nearly every month. Commercial and industrial loans exceeded $1.5 trillion this August, up from less than $1.2 trillion a year earlier. Real-estate loans exceeded $3.6 trillion, up from less than $3.4 trillion a year ago. Consumer loans were $845 billion, up from $737 billion. Credit standards are tougher, which is surely a good thing, but interest rates for creditworthy borrowers remain low.

The ongoing slow but steady availability of bank credit helps explain the much-remarked contrast between Wall Street and Main Street -- the shaky condition of exotic financial markets compared with relatively benign statistics for industrial production, retail sales, employment and the rest of the nonhousing economy. Most people go about their business without depending on investment banks or exotic varieties of commercial paper.

Second, recent events highlight the absurdity of the attempt by several pundits to blame recent problems on "financial deregulation." That complaint was aimed at the Financial Modernization Act of 1999, which passed the House by a vote of 362-57 and the Senate by 90-8, yanking the last brick out of the 1933 Glass-Steagall Act's regulatory wall between commercial banks and investment banks.

If it was somehow possible in today's world of global electronic finance to the rebuild such a wall, that would mean J.P. Morgan could not have bought Bear Stearns, Bank of America could not have bought Merrill Lynch, Barclays could not buy most of Lehman, and Goldman Sachs and Morgan Stanley could not become bank holding companies. It is hard to imagine how things would have worked out in that situation, but it surely would not have been an improvement.

Since the 1933 regulatory wall has collapsed as definitively as the Berlin Wall, all the giant financial conglomerates now face oversight and regulation by the Federal Reserve, the Securities and Exchange Commission, the Comptroller of the Currency and the Federal Deposit Insurance Corp. Innocents who seek security in regulation need to recall, however, that not one of those august agencies exhibited timely foresight or concern about the default risk among even prime mortgages in some locations, or about any lack of transparency with respect to bundling mortgages into securities. People do not become wiser, more selfless or more omniscient simply because they work for government agencies.

Wall Street was always a metaphor, of course, but so are words like "bailout" and "toxic" debt. Nationalization of Fannie Mae and Freddie Mac was a bailout for creditors (who received windfall gains), not for stockholders or executives. The federally enforced shotgun marriage between J.P. Morgan and Bear Stearns at the initially ridiculous price of $2 a share was no bailout for Bear. The 11.3% federal loan to AIG, contingent on the potential expropriation of 80% of shareholder value, is no bailout either.

By contrast, what was done to stop a run on the money-market funds is a real bailout which could encourage them to hold risky paper and also make it tougher for commercial banks to attract deposits. The proposal to buy up mortgage-backed securities is a bailout too, though the beneficiaries are not just the tattered remains of Wall Street. The bailout consists of shifting the risk of loss to taxpayers. Actual losses could not reach $700 billion unless the securities were literally worthless, which would mean the value of the underlying real estate fell to zero.

What was "toxic" for investment banks is not equally toxic for the Treasury Department because the government does not even bother to keep a balance sheet, much less abide by mark-to-market accounting rules. A powerful motive for converting investment banks into commercial banks is to get around those onerous balance-sheet rules that required fire-sale pricing of securities that were virtually unmarketable during a panicky scramble for liquidity. Strict adherence to those rules made patience a vice and a "buy and hold" approach impossible. This confirms what many of us have long been saying about the foolishness of letting arbitrary bookkeeping rules dominate economic reality.

Turning Wall Street into a bunch of commercial banks is a solution of sorts to a problem aggravated by foolish mark-to-market regulations, not by the inevitable demise of the 1933 wall between investment banks and commercial banks. Something good may yet come out of all this, because that wall never made much sense in the first place.

Mr. Reynolds, a senior fellow with the Cato Institute, is the author, most recently, of "Income and Wealth" (Greenwood Press, 2006).

BTW, yes and Greenspan has a new book. I wondeer what Scott Grannis thinks of Greenspan. I do not have the background to evaluate him one way or the other. I would think he did his best and hindsight is always the best opinion even if it is right that he bears some responsibility for the present problems. Gotta love all the political books that always seem to make the circuit just before a national election.The endless parade of Woodward books before every election is boring.

Anyway the main reason for my post:

Here it comes. The Hillary/Dem dream of socialism gets a boost. The end of our free capatilist system as we know it:

**** Sep 23, 2008 10:10 am US/Eastern Sen. Clinton: 'No Doubt' Obama Will WinNew York Democrat Says Taxpayers 'Could Be Left Holding The Bag' With $700 Billion Government ProgramSuggests Country Look At Some Great Depression-Era Type Of Governmental EntityNEW YORK (CBS) ― Sen. Hillary Rodham Clinton said Tuesday she worries that taxpayers could be left "holding the bag" with plans for a $700 billion government program to stabilize the country's distressed financial markets.

Interviewed on Tuesday morning on CBS's "The Early Show," she said she agrees that the situation is critical and that something must be done quickly. She said, "the house is on fire and we've got to call the fire department and put the fire out." But Clinton also said that Congress should not "give the Treasury a blank check" to straighten out the problem.

"What we also have to do is make sure that homeowners get some relief, that it's not just for the banks and the lenders," she said. Clinton added that "we also must begin to look at the root cause of this, which is these mortgages that people cannot afford."

The senator said she didn't think all responsibility for solving these problems should be vested in the Treasury Department, suggesting that "once we get through this immediate crisis," the country should look at some Great Depression-era type of governmental entity to deal with it.

"If we just turn this over to Treasury, I worry about what the outcome would be," she said in an interview on NBC's "Today" show.

She blamed part of the problem on "predatory lending and subprime lending" in the housing market.

Clinton said Tuesday that Barack Obama is going to be elected the next president and that she has "no doubt" about it.

"Barack Obama is being advised by the same peopole who got us out of the ditch in 1993," she said. "I think our ticket is well-equipped for handling the mess that they're going to inherit. Let's make no mistake about it: this is going to be one of the most difficult presidential transitions."

Clinton also said that while she recognizes that race and gender play a role in the minds of voters as they make their presidential choices, she believes enough people want change from Republican policies to put Obama over the top in November.

On CBS's "The Early Show," she was asked what she thought about Republican Sarah Palin's vice presidential candidacy. She said she thought any woman is going to face certain issues and questions but that "the bottom line is who is on top of the ticket."

Clinton called Republican presidential nominee John McCain a friend, but said that he has a record of supporting deregulationof business.

"Barack Obama's going to win. No doubt ... if anybody looks at the mess we're in today," she said.

She also said that she thinks Obama is best suited to straighten out the country's economic problems.

As I figure it, $700,000,000,000 divided by a population of 300,000,000 equals $2333 each. Before our government commits each of us to a share of this handout, it has some questions to answer:

Sunday, September 21, 2008

Before D.C. Gets Our Money, It Owes Us Some Answers [Newt Gingrich]

Watching Washington rush to throw taxpayer money at Wall Street has been sobering and a little frightening.

We are being told Treasury Secretary Henry Paulson has a plan which will shift $700 billion in obligations from private companies to the taxpayer.

We are being warned that this $700 billion bailout is the only answer to a crisis.

We are being reassured that we can trust Secretary Paulson "because he knows what he is doing".

Congress had better ask a lot of questions before it shifts this much burden to the taxpayer and shifts this much power to a Washington bureaucracy.

Imagine that the political balance of power in Washington were different.

If this were a Democratic administration the Republicans in the House and Senate would be demanding answers and would be organizing for a “no” vote.

If a Democratic administration were proposing this plan, Republicans would realize that having Connecticut Democratic senator Chris Dodd (the largest recipient of political funds from Fannie Mae and Freddie Mac) as chairman of the Banking Committee guarantees that the Obama-Reid-Pelosi-Paulson plan that will emerge will be much worse as legislation than it started out as the Paulson proposal.

If this were a Democratic proposal, Republicans would remember that the Democrats wrote a grotesque housing bailout bill this summer that paid off their left-wing allies with taxpayer money, which despite its price tag of $300 billion has apparently failed as of last week, and could expect even more damage in this bill.

But because this gigantic power shift to Washington and this avalanche of taxpayer money is being proposed by a Republican administration, the normal conservative voices have been silent or confused.

It’s time to end the silence and clear up the confusion.

Congress has an obligation to protect the taxpayer.

Congress has an obligation to limit the executive branch to the rule of law.

Congress has an obligation to perform oversight.

Congress was designed by the Founding Fathers to move slowly, precisely to avoid the sudden panic of a one-week solution that becomes a 20-year mess.

There are four major questions that have to be answered before Congress adopts a new $700 billion burden for the American taxpayer. On each of these questions, I believe Congress’s answer will be “no” if it slows down long enough to examine the facts.

Question One: Is the current financial crisis the only crisis affecting the economy?

Answer: There are actually multiple crises hurting the economy.

There is an immediate crisis of liquidity on Wall Street.

There is a longer time crisis of a bad energy policy transferring $700 billion a year to foreign countries (so foreign sovereign capital funds are now using our energy payments to buy our companies).

There is a longer term crisis of Sarbanes-Oxley (the last "crisis"-inspired congressional disaster) crippling entrepreneurial start ups, driving public companies private, driving smart business people off public boards, and driving offerings from New York to London.

There is a long term crisis of a high corporate tax rate driving business out of the United States.

No solution to the immediate liquidity crisis should further cripple the American economy for the long run. Instead, the liquidity solution should be designed to strengthen the economy for competition in the world market.

Question Two: Is a big bureaucracy solution the only answer?

Answer: There is a non-bureaucratic solution that would stop the liquidity crisis almost overnight and do it using private capital rather than taxpayer money.

Four reform steps will have capital flowing with no government bureaucracy and no taxpayer burden.

First, suspend the mark-to-market rule which is insanely driving companies to unnecessary bankruptcy. If short selling can be suspended on 799 stocks (an arbitrary number and a warning of the rule by bureaucrats which is coming under the Paulson plan), the mark-to-market rule can be suspended for six months and then replaced with a more accurate three year rolling average mark-to-market.

Second, repeal Sarbanes-Oxley. It failed with Freddy Mac. It failed with Fannie Mae. It failed with Bear Stearns. It failed with Lehman Brothers. It failed with AIG. It is crippling our entrepreneurial economy. I spent three days this week in Silicon Valley. Everyone agreed Sarbanes-Oxley was crippling the economy. One firm told me they would bring more than 20 companies public in the next year if the law was repealed. Its Sarbanes-Oxley’s $3 million per startup annual accounting fee that is keeping these companies private.

Third, match our competitors in China and Singapore by going to a zero capital gains tax. Private capital will flood into Wall Street with zero capital gains and it will come at no cost to the taxpayer. Even if you believe in a static analytical model in which lower capital gains taxes mean lower revenues for the Treasury, a zero capital gains tax costs much less than the Paulson plan. And if you believe in a historic model (as I do), a zero capital gains tax would lead to a dramatic increase in federal revenue through a larger, more competitive and more prosperous economy.

Fourth, immediately pass an “all of the above” energy plan designed to bring home $500 billion of the $700 billion a year we are sending overseas. With that much energy income the American economy would boom and government revenues would grow.

Question Three: Will the Paulson plan be implemented with transparency and oversight?

Answer: Implementation of the Paulson plan is going to be a mess. It is going to be a great opportunity for lobbyists and lawyers to make a lot of money. Who are the financial magicians Paulson is going to hire? Are they from Wall Street? If they’re from Wall Street, aren't they the very people we are saving? And doesn’t that mean that we’re using the taxpayers’ money to hire people to save their friends with even more taxpayer money? Won't this inevitably lead to crony capitalism? Who is going to do oversight? How much transparency is there going to be? We still haven't seen the report which led to bailing out Fannie Mae and Freddie Mac. It is "secret". Is our $700 billion going to be spent in "secret" too? In practical terms, will a bill be written in public so people can analyze it? Or will it be written in a closed room by the very people who have been collecting money from the institutions they are now going to use our money to bail out?

Question Four: In two months we will have an election and then there will be a new administration. Is this plan something we want to trust to a post-Paulson Treasury?

Answer: We don’t know who will inherit this plan.

The balance of power on election day will shift to either McCain or Obama. Who will they pick for Treasury Secretary? What will their allies want done? We are about to give the next administration a level of detailed control over big companies on a scale even FDR did not exercise during the Great Depression. Is this really wise?

For these reasons I hope Congress will slow down and have an open debate.

And in the course of that debate, I hope someone will introduce an economic recovery act that makes America a better place to grow jobs. I hope the details will be made public before the vote.

For more details on my action plan for getting the American economy back on track and building long-term economic prosperity, you can read this message recorded yesterday to American Solutions members.

In 1992, hedge-fund manager George Soros made $1 billion betting against the British pound. In 2007, John Paulson's Credit Opportunities fund correctly bet against subprime mortgages, clearing $15 billion for the year and $3.7 billion for him. Warren Buffett is now hoping to make big money on Goldman Sachs.

But these are small-time deals. My analysis suggests that Treasury Secretary Henry Paulson (a former investment banker, no less, not a trader) may pull off the mother of all trades, which could net a trillion dollars and maybe as much as $2.2 trillion -- yes, with a "t" -- for the United States Treasury.[The Paulson Plan Will Make Money for Taxpayers] Chad Crowe

Here's what's happened so far. New technology like electronic trading meant that Wall Street's bread-and-butter business of investment banking and trading stocks stopped making much money years ago. So investment banks took their enormous capital and at first packaged yield-enhanced, subprime mortgage loans into complex derivatives such as collateralized debt obligations (CDOs). Eventually and stupidly, these institutions owned them for themselves -- lots of them, often at 30-to-1 leverage. The financial products were made "safe" by insurance products known as credit default swaps, a credit derivative from companies such as AIG. When housing turned down, the mortgages and derivatives were worth a lot less and no one would lend Wall Street money anymore.

Then the piling on started. Hedge funds could short financial stocks and then bid down the prices of CDOs stuck on Wall Street's balance sheets. This was pretty easy to do in an illiquid market. Because of the Federal Accounting Standards Board's mark-to-market 157 rule, Wall Street had to write off the lower value of these securities and raise more capital, diluting shareholders. So the stock prices would drop, which is what the shorts wanted in the first place. It was all legit.

There is a saying on Wall Street that goes, "The market can stay irrational longer than you can stay solvent." Long Term Capital Management learned this lesson 10 years ago when it got its portfolio picked off by Wall Street as its short-term financing dried up. I had thought the opposite -- hedge funds picking off Wall Street -- would happen today. But in a weird twist, it's the government that is set up to win the prize.

Here's how: As short-term financing dried up, Fannie Mae and Freddie Mac's deteriorating financials threatened to trigger some $1.4 trillion in credit default swap payments that no one, including giant insurer AIG, had the capital to make good on. So Treasury Secretary Henry Paulson put Fannie and Freddie into conservatorship. This removed any short-term financing hassle. He also put up $85 billion in loan guarantees to AIG in exchange for 80% of the company.

Taxpayers will get their money back on AIG. My models suggest that Fannie and Freddie, on the other hand, are a gold mine. For $2 billion in cash up front and some $200 billion in loan guarantees so far, the U.S. government now controls $5.4 trillion in mortgages and mortgage guarantees.

Fannie and Freddie each own around $800 million in mortgage loans, some of them already at discounted values. They also guarantee the credit-worthiness of another $2.2 trillion and $1.6 trillion in mortgage-backed securities. Held to maturity, they may be worth a lot more than Mr. Paulson paid for them. They're called distressed securities for a reason.

Now Mr. Paulson is pitching Congress for $700 billion or more to buy distressed loans and CDOs from the rest of Wall Street, injecting needed cash onto balance sheets so that normal loans for economic activity can be restored. The trick is what price he will pay. Better mortgages and CDOs are selling for 70 cents on the dollar. But many are seriously distressed (15-25 cents on the dollar) because they are the last to be paid in foreclosures. These are what Wall Street wants to unload the quickest.

Firms will haggle, but eventually cave -- they need the cash. I am figuring Mr. Paulson could wind up buying more than $2 trillion in notional value loans and home equity and CDOs for his $700 billion.

So the U.S. will be stuck with a portfolio in the trillions of dollars in bad loans and last-to-be-paid derivatives. Where is the trade in that?

Well, unlike Mr. Buffett or any hedge fund, the Treasury and the Federal Reserve get to cheat. It's not without risk, but the Feds, with lots of levers, can and will pump capital into the U.S. economy to get it moving again. Future heads of Treasury and the Federal Reserve will be growth advocates -- in effect, "talking their book." While normally this creates a threat of inflation and a run on the dollar, and we may see dollar exchange rates turn south near term, don't expect it to last.

First, with Goldman Sachs and Morgan Stanley now operating as low-leverage bank holding companies, a dollar injected into the economy will most likely turn into $10 in capital (instead of $30 when they were investment banks). This is a huge change. Plus, a stronger U.S. economy, with its financial players having clean balance sheets, will become a safe haven for capital.

Europe is threatened by an angry Russian bear. The Far East, especially China, has its own post-Olympic banking house of cards of non-performing loans to deal with. Interest rates will tick up as the economy expands -- a plus for the dollar. Finally, a stronger economy driven by industry instead of financials means more jobs, less foreclosures and higher held-to-maturity payouts on this Fed loan portfolio.

You can slice the numbers a lot of different ways. My calculations, which assume 50% impairment on subprime loans, suggest it is possible, all in, for this portfolio to generate between $1 trillion and $2.2 trillion -- the greatest trade ever. Every hedge-fund manager will be jealous. Mr. Buffett is buying a small piece of the trade via his Goldman Sachs investment.

Over 10 years this could change the budget scenario in D.C., which can also strengthen the dollar. The next president gets a heck of a windfall. In the spirit of Secretary of State William Seward's purchase of Alaska for $7 million in 1867, this week may be remembered as Paulson's Folly.

Mr. Kessler, a former hedge-fund manager, is the author of "How We Got Here" (Collins, 2005).

It is beyond irritating to watch President Bush, Treasury Secretary Henry Paulson, and Federal Reserve Chairman Ben Bernanke gift-wrap their $700-billion early Christmas present for financially irresponsible bankers and the overleveraged borrowers who love them. These “three wise men” consider theirs the only method to stop the turmoil roiling trading desks from Gotham to Tokyo.

“Action by the Congress is urgently required to stabilize the situation and avert what otherwise could be very serious consequences for our financial markets and for our economy,” Bernanke told the Senate Banking Committee Tuesday.

But this mother of all government interventions is unlike a long, cold hypodermic needle in the belly: an inescapable misery, but preferable to death by rabies. There actually are desirable alternatives to building socialism and saddling every American man, woman, and child with another $2,300 in unjustified federal spending.

One option is to instruct the geniuses from Fannie Mae to Wall Street to deal with it. They made this mess; they should mop it up. Cut back, sell assets, develop fresh services, or get new jobs. Absent a federal bailout, Lehman Brothers sold parts of itself to Barclay’s Bank. Facing Uncle Sam’s cold shoulder, Merrill Lynch ran into the loving arms of Bank of America. Merrill’s customers will survive, and its employees will work for B of A or seek their fortunes elsewhere.

It may take time and tightened belts, but padlocking Washington’s bailout window will offer a generation of “masters of the universe” lessons that America’s Mr. Rogers-in-Chief cannot teach: Keep your winnings, but own your losses. If you fall on your face, especially after dancing drunk on the roof, Uncle Sam may empathize, but he no longer will rush in to swaddle you in silk sheets and place your bruised head on pillows stuffed with crisp $100 bills.

Other options exist, of course — and while they lack the bracing appeal of this sort of financial Darwinism, they remain far more attractive than our current policy of “survival of the fattest.”

Rep. Jeb Hensarling (R., Texas) chairs the Republican Study Committee, the congressional caucus of idea-driven, free-market stalwarts. These practicing Reaganites seem appalled to watch their GOP president morph before their eyes from GWB to LBJ to FDR. At a Capitol Hill press conference at high noon on Tuesday, Hensarling and a dozen RSC members expressed deep misgivings about Bush’s $700-billion baby. Preferring to drown it in the bathwater, Hensarling and his band of true believers rejected Bush’s collectivism and offered their own proposals for escaping this rubble — and returning America to a path of robust growth:

Give the capital-gains tax a two-year vacation. “Suspending capital gains taxes would bring as much as a trillion dollars of capital sitting on the sidelines back into the market,” Hensarling predicts. Also, as the Tax Foundation proposes, cutting America’s 35-percent corporate tax — the industrialized world’s second highest, after Japan’s — would boost U.S. global competitiveness. Since equity prices partially reflect long-term after-tax profits, lowering corporate levies should buoy stock markets.

Denationalize, then privatize Fannie and Freddie. “These troubled financial Frankensteins — created in a government laboratory — are not creatures of the free enterprise system,” Hensarling said. “We must ultimately take their monopoly powers away and return them to the marketplace.” Why not array Fannie’s and Freddie’s loans according to mortgage holders’ surnames? They then could be divided alphabetically into 26 units and auctioned off.

Strengthen the dollar. Bernanke should boost U.S. currency, not pose as America’s uber-stock broker. A strong dollar lowers inflation, cheapens oil, and soothes world markets.

Bush’s bailout bonanza began with $29 billion for Bear Sterns. Then came the taxpayer-financed purchase of an 80-percent stake in AIG. And while the public and press gaped open-mouthed at the $700 billion request to rescue the financial-services sector, Washington quietly passed $25 billion to the auto industry. Doubtless, credit-card companies now await their slab of bacon. This cavalcade of giveaways and takeovers monumentally betrays the Republican Party’s most sacred tenets.

LAST THURSDAY NIGHT Treasury Secretary Hank Paulson and Fed Chairman Ben Bernanke stood surrounded by the bipartisan leadership of Congress to announce that a consensus had emerged that drastic action was needed to save our financial system. On Saturday the first vague details of that action began to emerge. By the time of the first hearings on Tuesday a groundswell of popular opposition produced some of the most broad-based skeptical questioning of the nation's economic leadership that I can remember. What happened?

First, it is now obvious that the Thursday consensus to pass a bill was not backed by the reality of legislation, or even a coherent plan of action. When Washington let Lehman Brothers fail (after a century and a half of operations), many in Washington said that Lehman had had six months to get its problems revolved--since being put on notice when its sister firm Bear Stearns was bailed out--and had not done so. Hence it was denied the assistance Bear had gotten. But what had Washington been doing in the intervening six months to get ahead of the developing financial crisis? By the weekend it appeared that the answer was: about as much as Lehman.

Second, when the first details emerged, the focus of the plan was for the government to buy the assets in the financial system that were not easily valued and therefore could not be sold. They were clogging up the books and thereby consuming most of the spare capital in the system. Those that could be sold were being sold out of desperation at fire sale prices. For example, Merrill Lynch had sold assets at 22 cents on the dollar, and had to lend three-quarters of that amount to the buyer. Trouble was, if the government bought at those prices, the financial industry would take massive losses and many firms might go under. That meant that the only way the plan made sense was for the government to buy assets at prices well above current market values. Not even the most talented wordsmith could find a way of getting around the word "bailout" for this type of action. This meant bailing out the same gigantic firms which government regulators and prosecutors had been saying for months had used shady accounting practices and paid their CEOs tens of millions of dollars per year. I'm just an economist, but that hardly seems like a political winner to me.

Third, to make these purchases the government would have to set a price on assets that are so opaque and differentiated that no market price had been determined for over a year. This opacity led Wall Street to employ some of the smartest people in the world to come up with computer models to determine these prices, and when they did, the prices were so subject to small changes in underlying assumptions that they proved wildly volatile. Passing the plan meant asking members of Congress, most of whom would have to ask a staffer what the formula was for compound interest, to either figure out a fair price or trust the same geeks who got us into this mess in the first place to figure one out instead.

The most likely end game of this approach is passage of a bill that hands the job over to the geeks with so many constraints and conflicting objectives that the entire enterprise runs up against Arrow's Impossibility Theorem. (Kenneth Arrow got a Nobel Prize for formalizing a way of saying "you can't get there from here.") The resulting process would be open to manipulation by private players who could hire their own geeks to figure it out, and therefore almost certain to produce instant billionaires in the process. But, this outcome will still allow congressmen to go home to campaign and tell voters that they have both solved the problem and protected the taxpayer. After the process collapses and the Congress returns in January, the blame will be dumped on the appointed officials who were supposed to oversee the geeks assigned to complete the impossible task. A new process will then be created in January by people with even less experience and with the deterioration in the system much further advanced.

One likely way the new folks could proceed is to stay away from the tar pit of trying to bail out institutions directly and instead opt for an indirect approach. Specifically, the government might choose to bail out homeowners instead. Suppose all homeowners were allowed to refinance their existing mortgage at some low subsidized rate that was also extended to all new buyers, say 4 percent. One catch--the government would have recourse to the borrower and not just the house in the case of default. This is a huge broadening of the plan originally suggested by Martin Feldstein. Not everyone would take this up because it would mean they would have to pay the money back and not just default on their mortgage. So, it would quickly separate the good mortgages from the bad ones that are creating problems in the system.

For those who did take up the plan, a wave of prepayments would begin that would trigger positive cash flow and reduce the risk to all that derivative paper the financial service industry now holds. Prices on that paper would quickly rise and firms would enjoy both more liquidity and more capital. For those who did not refinance, the expectation would be that the house was so far under water that it will ultimately produce a loss. This would help clarify precisely just how much the losses were in the system and on each of the many securitized products and mortgage derivatives as well.

But the biggest advantage is that it avoids the quagmire in which the political class now finds itself. No need for direct bailouts, no need to warehouse paper, no need to hire geeks to figure it all out, and no instant billionaires who simply gamed the system. Better yet for those up for election, no political complaints since it is the voters themselves who were being bailed out.

Lawrence B. Lindsey, a former governor of the Federal Reserve, was special assistant to President Bush for economic policy and director of the National Economic Council at the White House. His most recent book is What a President Should Know . . . but Most Learn Too Late (Rowman and Littlefield).

What We LearnedFrom Resolution TrustBy L. WILLIAM SEIDMAN and DAVID C. COOKE

As individuals who were intimately involved in the resolution of this country's last financial crisis, we follow with great interest Treasury Secretary Henry Paulson's proposal to acquire distressed real-estate assets from financial institutions.

The current situation threatens our economy more than the savings and loan and banking crisis of the 1980s and early 1990s. The Treasury secretary should be congratulated for moving quickly and decisively.

We would like to offer some thoughts based on our experiences in starting up and operating the government-owned Resolution Trust Corporation, as well as a similar type of operation undertaken by the Federal Deposit Insurance Corporation for dealing with failed banks.

The RTC was charged with resolving nearly 750 failing savings and loan institutions holding $400 billion in assets, and the FDIC had an additional $200 billion from failed banks. Most of these assets were loans to homeowners, builders and developers. Many of the assets, especially construction and development loans, had no established market or "fair value."

The major difference between then and now is that the RTC was, with only a couple of exceptions, dealing with S&Ls closed by their chartering agency. This meant the RTC took over the assets after the institution failed, not before. So the RTC did not have to first negotiate a "fair value purchase price" with a troubled seller. Our experience with past U.S. bank and S&L assistance efforts, as well as those of other countries, leads us to believe that deciding what price to pay -- and which institution to "assist" by buying their assets -- will not be easy.

Guidelines should be established regarding which institutions will be assisted, and how the government will minimize losses, should "fair value" prices prove too high. One option is to not pay all cash upfront. Another method of protecting the taxpayer against overpayment would be for the government to have the right to recover some part of losses suffered on the later sale of assets. Other countries with asset-acquisition programs found themselves conflicted between paying too much to help the bank and trying to avoid losses eventually realized.

Clear guidelines for the management process should be established as promptly as possible for the real-estate loans and/or mortgage-backed securities acquired by Treasury. Like those owned by the RTC, all will require some level of active management.

Buying and managing home mortgages acquired by Treasury will be very challenging. Valuation will be heavily influenced by local real-estate markets and the actions available to the lenders. Restrictions on lender actions or sale prices should be avoided to help maximize recoveries and minimize taxpayers' losses. Restructuring loans often provides an attractive option that avoids foreclosure and keeps families in their homes. But it is important that the lender be allowed to pursue other options when determined to be in the best interest of the taxpayer.

The most difficult loans for the RTC to manage were loans to developers and builders. Our guess is such loans are a looming problem that has not yet been fully recognized. While it is not clear if the proposal currently addresses such loans, it should. Their treatment will impact the property values underlying loans acquired by Treasury.

The RTC started a number of sales initiatives. For the more difficult real-estate loans and properties, we started hiring contractors to manage and sell the assets. But aligning the interests of contractors with the RTC proved very difficult.

The RTC saw that the larger its inventory of distressed assets became, the more the overhang impeded the ability of the markets to determine value and function effectively. We concluded that the only way to stimulate markets as well as avoid conflicting mandates was to quickly move assets into private-sector ownership and expertise, by selling them in bulk in an open and competitive manner.

Here are the most important lessons we learned from our experiences in the late '80s and early '90s:

- Acquired assets require active management. Assets tend to lose value while in government hands, as the government seldom can duplicate a private owner's interest in enhancing value. The RTC employed over 10,000 people in the first year of operation.

- Holding large inventories of assets will lead to depressed prices. No one wants to buy when the market has a large overhang of assets just waiting to be dumped when prices improve.

- To get the market started, assets have to be sold at very low prices. Such sales will attract buyers, with a resulting increase in prices. At the same time, selling at low prices could trigger accusations that the agency is "depressing the market."

- Every government sale or purchase creates winners and losers. This results in intense political and economic pressures to influence the actions of the agency. The RTC's independent governance and operations protected against fraud and political influence.

The Treasury proposal will undoubtedly raise many conflicts similar to those seen by the RTC. In our experience, government ownership and management of assets rarely increases value. Moving assets openly, fairly and promptly to sound private-sector owners is the best way to minimize taxpayers' losses. If the RTC hadn't adopted this approach, it might still be around today.

Mr. Seidman is former FDIC and RTC chairman. Mr. Cooke is former deputy FDIC chairman and RTC executive director.

The Treasury plan to buy illiquid financial assets has been widely criticized as being unfair to taxpayers, who will have to bear losses ahead of shareholders of the institutions that will be bailed out.[The Public Deserves a Better Deal] Corbis

There is a better alternative to stabilize the markets: Invest the $700 billion of taxpayer money in senior preferred stock of the troubled financial institutions that pose systemic risks. Let's call this the "Preferred plan." In fact, it is the Fannie Mae and Freddie Mac model -- which the Treasury Department has already endorsed and used in practice. It is also the approach Warren Buffett used for his investment in Goldman Sachs.

There are major problems with the Treasury plan. First, by buying banks' worst assets at above-market prices, taxpayers take an immediate economic loss -- while transferring wealth to shareholders and executives of the very institutions that brought on the financial crisis.

Second, this plan puts too much discretionary power in the hands of Treasury officials. Who determines what financial assets are purchased and at what prices? Who determines which bank gets to benefit from these taxpayer subsidies? Will bank shareholders continue to receive dividends, and executives continue to get paid huge bonuses?

When financial institutions borrow massive amounts of money to invest in assets that are now found to be illiquid and poorly performing, it is not the responsibility of taxpayers to bear the resulting losses. These losses should be borne by the shareholders.

If taxpayers have to step in and provide capital to keep operating enterprises that the government decides are key to the functioning of the economy as a whole, taxpayers must receive protection.

Treasury Secretary Henry Paulson said at the Senate Banking Committee hearing this week, "[the] Fannie Mae and Freddie Mac [interventions] worked the way they were supposed to." These enterprises continued to function, maintaining homeowner access to and lowering the cost of mortgage financing. However, managements of these companies had to leave and forfeit the compensation packages they had negotiated.

Shareholders had their dividends blocked and remain first in line to bear losses, as they should have been. Taxpayers came both first and last -- first to get paid back, as the new preferred stock is senior to all shareholders; and last in realizing losses, as common and other preferred equity would be extinguished before the taxpayers would be at risk.

This mechanism -- purchases of senior preferred stock with warrants in troubled institutions -- addresses the problems with the Treasury plan. The financial market is stabilized, companies get recapitalized, failures are avoided, debt securities are supported, and time is gained for illiquid assets to mature.

The institutions continue to function, their cost of funding will decline as equity capital increases, and innocent third parties like bank depositors, broker/dealer clients and insurance-policy holders are all protected. The only difference is that potential losses are kept with the shareholders where they belong.

The Treasury plan would also entail larger outlays than the Preferred plan. By allowing all banks to sell their worst assets to Treasury at inflated prices, taxpayers would be subsidizing healthy banks which have access to private capital (Goldman Sachs, J.P. Morgan, Wells Fargo, and Bank of America, for example) as well as banks that don't have a private alternative. But under a Preferred plan, only banks that don't have a private alternative will be given federal assistance. This would reduce the outlay otherwise required to solve the crisis.

Few people familiar with the issues deny that Treasury action is needed to stabilize the financial markets. However, the question is who should bear the cost?

Under the Treasury plan the taxpayer pays the price. Under a Preferred plan, the shareholders of the firms who created the problems bear the first loss. Who do you think should pay?

Before committing $700 billion of our money, we should encourage Congress to take a few extra days to get this legislation right.

Mr. Paulson is president and portfolio manager of Paulson & Co. Inc., a New York-based investment management firm.

This paper, in its entirety, can be found at: www.heritage.org/Research/Economy/wm2079.cfm Produced by the Center for Legal and Judicial Studies Published by The Heritage Foundation 214 Massachusetts Avenue, NE Washington, DC 20002–4999 (202) 546-4400 • heritage.org

Nothing written here is to be construed as necessarily reflecting the views of The Heritage Foundation or as an attempt to aid or hinder the passage of any bill before Congress. All Deliberate Speed: Constitutional Fidelity and Prudent Policy Go Hand in Hand in Fixing the Credit Crisis

Todd F. Gaziano and Andrew M. Grossman

Even in times of difficulty or crisis, the constitutional design for legislation requires careful, bicameral deliberation and presentment to the President. For sound policy and constitutional reasons, Congress should not recess until it acts on a solution to the credit crisis, but it should also be mindful of the virtues of calm deliberation and the dangers to liberty of a crisis mentality. The mounting resistance to the Administration’s proposal presents an opportunity for careful deliberation. The constitutional and policy concerns expressed by many Members of Congress and thoughtful scholars this past week must be thoroughly considered.

No one doubts the importance of Treasury Secretary Henry Paulson’s call for immediate legislative action to calm the financial markets, which have the potential to wreak long-term damage to the world economy, but the initial deadline with which he urged Congress to act on a dramatic bail- out plan raises risks that Congress must avoid: either acting imprudently (and with serious constitutional consequences) or not acting at all before it recesses.

Members of Congress had planned to depart Washington on Friday to spend the month campaigning for votes, but they should stay in session around the clock if that is necessary to complete action before the end of the month. The exigencies of electoral politics should not be allowed to keep Congress from its constitutional duties. That result—Members of Congress abandoning Washington in a time of crisis to campaign for their own reelections—would be irresponsible. It is also, in all likelihood, unnecessary: What statesman would believe that his constituents would exact punishment for staying a few extra days to do the people’s work? In the minds of true statesmen, this con- test between constitutional values and politicking should not present a conflict.

Constitutional and Policy Concerns Converge. As many have come to realize this week, there are some fundamental constitutional values at stake in the present debate. The Paulson proposal, and the several congressional proposals based upon it, raise substantial constitutional questions regarding: (1) Congress’s enumerated power—or lack thereof—to intervene with private markets in the manner contemplated, (2) the lack of meaningful standards to guide the extremely broad grant of discretion to the Treasury secretary (the “legislative delegation” problem), (3) limitations on judicial review over the exercise of that almost limitless discretion, and (4) related separation of powers concerns. From a constitutional standpoint, the current versions of the legislation are different in scope, and especially in kind, from almost any federal legislation that has come before. In short, many analogies to past emergency economic powers, such as those exercised in response to the thrift failures of the 1980s, are not on point with regard to these central constitutional concerns. Rather than rely on these precedents, Congress must take the time to work through these constitutional concerns.

And these concerns are serious, regardless of how the courts might resolve them. Some would treat the Constitution as a legalistic document and employ narrow legalistic arguments to circumvent its strictures and protections. The substance of this debate, however, should not turn on what provisions might or might not pass muster with the courts under a pinched conception of our fundamental law. Rather, it is the principles the Constitution embodies, which have served us well through so many crises, that should be the focus of debate. In short, Americans should take little comfort that legislation might barely pass muster in the courts if the legislation does serious damage to the underlying constitutional principles that were designed to protect our individual rights against governmental usurpations.

In particular, legal scholars across the ideological spectrum recognize that, with regard to sweeping and seemingly standardless delegations of discretion to the executive branch, the courts have not been assertive in policing this aspect of the constitutional separation of powers. Yet even under the courts’ permissive, modern approach to such delegations, the delegation of authority in the legislation that some recommend for swift passage is question- able. This counsels caution.

Moreover, fidelity to our constitutional principles also coincides with prudent policy prescriptions. Those who argue that we need to suspend the fundamental charter in order to save it (or the economy) have it backward. Our fundamental charter has always been a bulwark for the free market. The recommendations below to address constitutional concerns should not only improve the short-term value of any emergency legislation; it should also support the long-term viability of free markets and, ultimately, free people.

Needed Constitutional Changes. To satisfy the substantial constitutional and policy concerns— if not the Constitution itself—the draft legislation must cabin the scope and character of the Treasury secretary’s discretion, connect the exercise of that discretion to legitimate government purposes, and allow Americans adversely affected to seek meaningful judicial review. If the bailout is to pass constitutional muster, lawmakers must concern themselves with at least the following specifics, while keeping in mind the broader outlines of its constitutional authority:

• Type and Scope of Indebtedness. The type of financial instruments or debt that the secretary can purchase, as well as the industries that may seek relief, should be defined by statute carefully so as to limit the secretary’s discretion. There are various ways to do this that would preserve the discretion necessary for the secretary to achieve the goals of the legislation and provide the limits necessary to protect the taxpayers. For instance, the legislation could expressly cover defined mortgage-related, non-equity securities of the type normally held by financial institutions. In addition, Congress and the administration could work together to identify other relevant, non- debt securities and set forth the circumstances under which the secretary could acquire them. If the nature of the economic problems changes, Congress may choose to expand the scope of authority in specific ways rather than granting a blank check at the outset. This and future Administrations should bear the burden of defining and limiting the necessary financial instruments or debt that they are seeking power to manage. Indeed, Congress should exercise a healthy suspicion if the Administration cannot define the scope of the authority it needs. The revolving nature of expenditures should also be capped. In the Administration proposal, the only limitation was the total value of securities the government could hold at any one time, which was $700 billion. The House bill con- verted that figure into an overall cap. Congress should impose some overall limit and stand ready to reconsider the cap if additional expenditures prove necessary.

• Standards to Guide the Secretary’s Discretion. It is questionable whether the current bills satisfy the court-created test of providing an “intelligible principle” to guide the secretary’s discretion (see, e.g., Whitman v. American Trucking Association), but that minimum standard is woefully inadequate for citizens and Members of Congress who care about the constitutional order. Congress must undertake the hard work of crafting legislative alternatives that achieve vital ends without straining our constitutional structure. In order to do so, the legislation itself must contain an objective set of criteria that would guide the secretary’s exercise of discretion in practice and not just in theory. The criteria that the government has employed in deciding when to act (e.g., Bear Stearns, AIG, etc.) and when not to act (e.g., Lehman Brothers) suggest that some guiding principle is necessary, and the Administration should be made to articulate it expressly and ex- pose it to the process of democratic consideration. In contrast, the existing drafts provide almost no meaningful standards to cabin the secretary’s discretion on what debt he may buy, for what purposes, to whom he may sell it, and on what terms. The definition of “troubled” assets is also unreasonably open-ended and not subject to judicial review. The two sweeping, subjective findings the secretary must make in the Administration proposal (three in the House bill) do not seriously limit his subsequent actions. Coupled with the existing limitation on judicial review, his discretion to manage “troubled” markets, “pro- vide stability,” or “prevent disruption” is almost limitless. Equally important, that a particular market is “troubled” or that there is a risk of “disruption” is still a questionable ground for action if there is no legitimate government interest involved. The statute should set forth some objective criteria that connect the particular market problem with a traditional government purpose—e.g., currency stabilization. That connection should not be fictionalized or unreason- ably tenuous, or it will simply serve as a bad precedent for other questionable delegations. With regard to all of these factors, the objective criteria must actually operate to guide and some- times limit the secretary’s exercise of discretion and not merely serve as a hortatory preamble for congressional action.

• Meaningful Judicial Review. It might be reason- able to subject particular factual determinations made by the secretary to a deferential standard of review and to limit certain types of judicial remedies (e.g., injunctions and other equitable relief). But citizens adversely affected by the government’s actions must be able to seek a redress in the courts for fundamental constitutional violations or damages at law.

• Sunset of All Regulatory Authority. Congress can codify or expand regulatory authority within two years if it proves necessary and prudent. How- ever, there is no sound reason to sunset some of the authorities under the proposed legislation but allow unlimited discretion to issue market regulations that will never sunset, as the current proposals provide. All regulations promulgated under the authority of the emergency legislation should sunset with the rest of the statute absent subsequent congressional action.

This combination of changes will go far to addressing the substantial constitutional questions about the existing proposals. If the scope of the authority is carefully defined, the standards for proper action are set forth in the statute, and those two limits are subject to meaningful court review, then citizens can at least know whom to hold accountable and where to go for redress of grievances. The ensuing changes will also move the proposals in the right policy direction as well.

Bicameral for a Reason. As Alexis De Tocqueville observed: “To divide legislative strength, thus to slow the movement of political assemblies…are the sole advantages” of our system of legislative bicameralism. Congress needs to act swiftly to address the financial crisis, but it also needs to deliberate.

—Todd F. Gaziano is the Director of, and Andrew M. Grossman is Senior Legal Policy Analyst in, the Center for Legal and Judicial Studies. They wish to thank Heritage colleagues James L. Gattuso and David C. John for their contributions.

Link to a very lengthy IMF paper examining 42 banking crises in 37 countries. An excerpt:

Existing empirical research has shown that providing assistance to banks and their borrowers can be counterproductive, resulting in increased losses to banks, which often abuse forbearance to take unproductive risks at government expense. The typical result of forbearance is a deeper hole in the net worth of banks, crippling tax burdens to finance bank bailouts, and even more severe credit supply contraction and economic decline than would have occurred in the absence of forbearance.

Cross-country analysis to date also shows that accommodative policy measures (such as substantial liquidity support, explicit government guarantee on financial institutions' liabilities and forbearance from prudential regulations) tend to be fiscally costly and that these particular policies do not necessarily accelerate the speed of economic recovery.

***But the investment mistakes would surely have been less extreme, and ultimately their damage more containable, if not for the enormous political support and subsidy for mortgage credit. Beware politicians who peddle fables that cast themselves as the heroes***

Have you seen Pelosi, Dodd, and Frank come out fo their weedend meetings congratulating themselves and of course pointing out how *they* fixed Bush's bill? And The two gentlemen praise the madam speaker on how *she* and she alone came oup with the solution to an impasse.

I doubt I was not the only one enraged by this circus.

The Financial mess is a Godsend for BO. Perhaps Israel will not wait for the election to bomb Iran to try to focus the attention more on foreign policy threats and help (?) McCain. Not that I think they should but just wondering.

While our country is distracted N. Korea is back to making bombs, Venezuela is now starting a nuclear energy program. The timing is perfect for our enemies. And best of all for them we have BO looking like he is going to cruise in and spend the next 4- 8 years weakening our country abroad. But the good news is more of us will speak French and we will be loved by all.

A $25 billion bailout of government-backed mortgage giant Fannie Mae is now planned. But Fannie Mae has such political power that its crooked managers will probably never be held accountable for their fraud in any way, unlike the Enron executives who went to jail. Instead, its lending authority will likely expand under federal mortgage bailout bills.

Paul Gigot, a Wall Street Journal editor, describes the personal vilification he has received over the years after the Journal began warning, prophetically, that Fannie Mae was engaged in fraudulent accounting, and that the taxpayers might some day have to pick up the tab. (To award themselves millions of dollars in bonuses, Fannie Mae’s managers used Enron-style fraudulent accounting). Fannie Mae’s managers, he notes, were ”unique in their thuggery” and arrogance.

When conservative Congressmen tried to rein it in, Fannie Mae responded with an avalanche of lies and political reprisals. It told Wisconsin Congressman Paul Ryan’s constituents that he wanted to raise the rates on their existing mortgages, a complete fabrication. And when Florida Congressman Cliff Stearns began investigating its fraudulent accounting, it got jurisdiction over its accounting practices transferred to another committee run by Michael G. Oxley, who worked in tandem with liberal stalwart Barney Frank to cover up the abuses at Fannie Mae and kill any reform legislation.

(Congressman Michael Oxley was the co-author of the devastatingly-costly and wasteful Sarbanes-Oxley Act, which ”created more busywork for accountants than real protection against abuses,” according to David Ignatius in the Washington Post. Oxley received generous donations from the big accounting firms, which were responsible for failing to detect Enron’s fraudulent accounting. The Sarbanes-Oxley law has made those firms fabulously wealthy, increasing the volume of work they receive by making auditing of public companies needlessly complicated. The big accounting firms now must be paid to evaluate and supervise companies’ “internal controls,” such as which employee has access to which computer password. The Sarbanes-Oxley Act has cost the stock market over a trillion dollars in value, and imposed ongoing compliance costs exceeding $35 billion per year, while diverting attention away from corporate incompetence at mortgage lender Countrywide Financial, a close Fannie Mae ally. It also created an unaccountable agency, the Public Company Accounting Oversight Board, to create mountains of red tape to enrich big accounting firms at the expense of productive businesses. Like Fannie Mae, it is nominally “private” to evade accountability and open-government laws (even though in reality, it is a governmental agency, and unlike Fannie, qualifies as such under the Supreme Court’s Lebron decision).

Fannie Mae was run by liberal power brokers like Franklin D. Raines who even now are unrepentant about their thuggery and accounting fraud. Franklin Raines recently took to the pages of the Washington Post to attack as “ideologues” the banking experts in the Bush Administration who had long and prophetically warned about the dangers of Fannie Mae’s risky practices. I published a letter to the editor in response criticizing Raines for his utter gall in lecturing whistleblowers about how Fannie should be managed. But amazingly enough, he continues to be treated like a financial hotshot. Law Professor James Lindgren has a post about Fannie Mae aptly entitled “Fannie Mae’s Thugs.”

The US and global financial crisis is becoming much more severe in spite of the Treasury rescue plan. The risk of a total systemic meltdown is now as high as ever

Nouriel Roubini | Sep 29, 2008

It is obvious that the current financial crisis is becoming more severe in spite of the Treasury rescue plan (or maybe because of it as this plan it totally flawed). The severe strains in financial markets (money markets, credit markets, stock markets, CDS and derivative markets) are becoming more severe rather than less severe in spite of the nuclear option (after the Fannie and Freddie $200 billion bazooka bailout failed to restore confidence) of a $700 billion package: interbank spreads are widening (TED spread, swap spreads, Libo-OIS spread) and are at level never seen before; credit spreads (such as junk bond yield spreads relative to Treasuries are widening to new peaks; short-term Treasury yields are going back to near zero levels as there is flight to safety; CDS spread for financial institutions are rising to extreme levels (Morgan Stanley ones at 1200 last week) as the ban on shorting of financial stock has moved the pressures on financial firms to the CDS market; and stock markets around the world have reacted very negatively to this rescue package (US market are down about 3% this morning at their opening).

Let me explain now in more detail why we are now back to the risk of a total systemic financial meltdown…

It is no surprise as financial institutions in the US and around advanced economies are going bust: in the US the latest victims were WaMu (the largest US S&L) and today Wachovia (the sixth largest US bank); in the UK after Northern Rock and the acquisition of HBOS by Lloyds TSB you now have the bust and rescue of B&B; in Belgium you had Fortis going bust and being rescued over the weekend; in German HRE, a major financial institution is also near bust and in need of a government rescue. So this is not just a US financial crisis; it is a global financial crisis hitting institutions in the US, UK, Eurozone and other advanced economies (Iceland, Australia, New Zealand, Canada etc.).

And the strains in financial markets – especially short term interbank markets - are becoming more severe in spite of the Fed and other central banks having literally injected about $300 billion of liquidity in the financial system last week alone including massive liquidity lending to Morgan and Goldman. In a solvency crisis and credit crisis that goes well beyond illiquidity no one is lending to counterparties as no one trusts any counterparty (even the safest ones) and everyone is hoarding the liquidity that is injected by central banks. And since this liquidity goes only to banks and major broker dealers the rest of the shadow banking system has not access to this liquidity as the credit transmission mechanisms is blocked.

After the bust of Bear and Lehman and the merger of Merrill with BofA I suggested that Morgan Stanley and Goldman Sachs should also merge with a large financial institution that has a large base of insured deposits so as to avoid a run on their overnite liabilities. Instead Morgan and Goldman went for the cosmetic approach of converting into bank holding companies as a way to get further liquidity support – and regulation as banks – of the Fed and as a way to acquire safe deposits. But neither institution can create in a short time a franchise of branches and neither one has the time and resources to acquire smaller banks. And the injection of $8 b of Japanese capital into Morgan and $5 b of capital from Buffett into Goldman is a drop in the ocean as both institutions need much more capital. Thus, the gambit of converting into bank while not being banks yet has not worked and the run against them has accelerated in the last week: Morgan’s CDS spread went through the roof on Friday to over 1200 and the firm has already lost over a third of its hedge funds clients together with their highly profitable prime brokering business (this is really a kiss of death for Morgan); and the coming roll-off of the interbank lines to Morgan would seal its collapse. Even Goldman Sachs is under severe stress losing business, losing money, experiencing a severe widening of its CDS spreads and at risk of losing most of its values most of its lines of business (including trading) are now losing money.

Both institutions are highly recommended to stop dithering and playing for time as delay will be destructive: they should merge now with a large foreign financial institution as no US institution is sound enough and large enough to be a sound merger partner. If Mack and Blankfein don’t want to end up like Fuld they should do today a Thain and merge as fast as they can with another large commercial banks. Maybe Mitsubishi and a bunch of Japanese life insurers can take over Morgan; in Europe Barclays has its share of capital trouble and has just swallowed part of Lehman; while most other UK banks are too weak to take over Goldman. The only institution sound enough to swallow Goldman may be HSBC. Or maybe Nomura in Japan should make a bid for Goldman. Either way Mack and Blankfein should sell at a major discount of current price their firm before they end up like Bear and be offered in a few weeks a couple of bucks a share for their faltering operation. And the Fed and Treasury should tell them to hurry up as they are both much bigger than Bear or Lehman and their collapse would have severe systemic effects.

When investors don’t trust any more even venerable institutions such as Morgan Stanley and Goldman Sachs you know that the financial crisis is as severe as ever and the fear of collapse of counterparties does not spare anyone. When a nuclear option of a monster $700 billion rescue plan is not even able to rally stock markets (as they are all in free fall today) you know this is a global crisis of confidence in the financial system. We were literally close to a total meltdown of the system on Wednesday (and Thursday morning) two weeks ago when the $85 b bailout of AIG led to a 5% fall in US stock markets (instead of a rally). Then the US authorities went for the nuclear option of the $700 billion plan as a way to avoid the meltdown together with bans on short sales, a guarantee of money market funds and an injection of over $300 billion in the financial system. Now the prospect of this plan passing (but there is some lingering deal risk the votes in the House are not certain) -as well as the other massive policy actions taken to stop short selling “speculation” and support interbank markets and money market funds - is not sufficient to make the markets rally as there is a generalized loss of confidence in financial markets and in financial institutions that no policy action seem to be able to control.

The next step of this panic could become the mother of all bank runs, i.e. a run on the trillion dollar plus of the cross border short-term interbank liabilities of the US banking and financial system as foreign banks as starting to worry about the safety of their liquid exposures to US financial institutions; such a silent cross border bank run has already started as foreign banks are worried about the solvency of US banks and are starting to reduce their exposure. And if this run accelerates - as it may now - a total meltdown of the US financial system could occur. We are thus now in a generalized panic mode and back to the risk of a systemic meltdown of the entire financial system. And US and foreign policy authorities seem to be clueless about what needs to be done next. Maybe they should today start with a coordinated 100 bps reduction in policy rates in all the major economies in the world to show that they are starting to seriously recognize and address this rapidly worsening financial crisis.

The $700 billion bailout bill is palatable to no one. It’s a huge price tag. It was originally presented to Congress as all but a fait accompli. Secretary of the Treasury Henry Paulson and Federal Reserve Chairman Ben Bernanke have been underwhelming in selling the plan on Capitol Hill. And it’s hated by a public suspicious of the country’s elites, whether in Washington or on Wall Street.

Put that all together with a reflex against such a massive governmental intervention among House Republicans, and it’s understandable that so many of them voted against it and the bill went down yesterday. They were immediately the targets in the Beltway blame game, although there’s plenty of it to go around. House Speaker Nancy Pelosi, who has been acrimoniously partisan over the last few days (calling Republicans “unpatriotic” over the weekend), delivered an obstreperous anti-Republican speech on the House floor prior to the vote, apparently unaware of the delicacy of the moment. She didn’t deliver five of her own committee chairmen and lost more than a dozen of her fellow California Democrats. Ninety-five Democrats voted against the plan; if 13 more had voted “aye,” the bailout would have passed.

But as a practical matter, Democrats wanted as much political cover as possible to pass the unpopular Bush administration proposal. The Republican leadership delivered only a third of its caucus. The Republican opponents marshaled arguments that ordinarily would win us over, for instance, about the plan representing “the slippery slope to socialism.” But we believe these arguments fall down in the current crisis. If the crunch that Paulson and Bernanke are warning about comes, it will squeeze off credit — the very lifeblood of capitalism — to businesses, entrepreneurs, and consumers all around the country. The Paulson plan is an intervention designed to keep capitalism functioning rather than supplant it. If it is successful, the assets the government buys will be sold back on the market (perhaps at a profit), after the panic passes.

There are alternatives to the Paulson plan, some of which are better or worse from a free-market perspective. But all of them involve major government action because in a financial crisis like this — originally stoked by misbegotten government policies — only the government has enough capital to backstop the system. It is the nature of financial panics to destroy institutions and wealth willy-nilly. Insisting only on private action in a crisis this large is like counting on private emergency response to a hurricane or on a private military to fight the country’s wars.

Swallowing hard, some of the most impressive Republicans in the House realize this, not just top leaders John Boehner and Roy Blunt, but the next generation of conservative leaders, members like Eric Cantor of Virginia, Adam Putnam of Florida, and Paul Ryan of Wisconsin. These aren’t socialists, creeping or otherwise. Paul Ryan, a principled conservative who has taken upon himself the lonely task of sponsoring legislation to tackle the nation’s entitlement programs, hated having to support the Paulson plan. But on the House floor Monday, he called it a “Herbert Hoover” moment. He noted the calculation of many of his colleagues: “We’re all worried about losing our jobs. Most of us say, ‘I want this thing to pass, but I want you to vote for it — not me.’ ” That, of course, is a formula for the legislation going down. “We’re in this moment, and if we fail to do the right thing,” he said, “heaven help us.”

Jeffrey Miron: Government encouraged lenders to relax their standardsMortgages were given to people unqualified to repay them, he saysMiron: Rather than a bailout, government should let firms go bankruptTalk of economic Armageddon is scare-mongering, Miron says

By Jeffrey A. MironSpecial to CNN

Editor's note: Jeffrey A. Miron is senior lecturer in economics at Harvard University. A Libertarian, he was one of 166 academic economists who signed a letter to congressional leaders last week opposing the government bailout plan.

CAMBRIDGE, Massachusetts (CNN) -- Congress has balked at the Bush administration's proposed $700 billion bailout of Wall Street. Under this plan, the Treasury would have bought the "troubled assets" of financial institutions in an attempt to avoid economic meltdown.

This bailout was a terrible idea. Here's why.

The current mess would never have occurred in the absence of ill-conceived federal policies. The federal government chartered Fannie Mae in 1938 and Freddie Mac in 1970; these two mortgage lending institutions are at the center of the crisis. The government implicitly promised these institutions that it would make good on their debts, so Fannie and Freddie took on huge amounts of excessive risk.

Worse, beginning in 1977 and even more in the 1990s and the early part of this century, Congress pushed mortgage lenders and Fannie/Freddie to expand subprime lending. The industry was happy to oblige, given the implicit promise of federal backing, and subprime lending soared.

This subprime lending was more than a minor relaxation of existing credit guidelines. This lending was a wholesale abandonment of reasonable lending practices in which borrowers with poor credit characteristics got mortgages they were ill-equipped to handle.

The fact that government bears such a huge responsibility for the current mess means any response should eliminate the conditions that created this situation in the first place, not attempt to fix bad government with more government.

The obvious alternative to a bailout is letting troubled financial institutions declare bankruptcy. Bankruptcy means that shareholders typically get wiped out and the creditors own the company.

Bankruptcy does not mean the company disappears; it is just owned by someone new (as has occurred with several airlines). Bankruptcy punishes those who took excessive risks while preserving those aspects of a businesses that remain profitable.

In contrast, a bailout transfers enormous wealth from taxpayers to those who knowingly engaged in risky subprime lending. Thus, the bailout encourages companies to take large, imprudent risks and count on getting bailed out by government. This "moral hazard" generates enormous distortions in an economy's allocation of its financial resources.

Thoughtful advocates of the bailout might concede this perspective, but they argue that a bailout is necessary to prevent economic collapse. According to this view, lenders are not making loans, even for worthy projects, because they cannot get capital. This view has a grain of truth; if the bailout does not occur, more bankruptcies are possible and credit conditions may worsen for a time.

Talk of Armageddon, however, is ridiculous scare-mongering. If financial institutions cannot make productive loans, a profit opportunity exists for someone else. This might not happen instantly, but it will happen.

Further, the current credit freeze is likely due to Wall Street's hope of a bailout; bankers will not sell their lousy assets for 20 cents on the dollar if the government might pay 30, 50, or 80 cents.

The costs of the bailout, moreover, are almost certainly being understated. The administration's claim is that many mortgage assets are merely illiquid, not truly worthless, implying taxpayers will recoup much of their $700 billion.

If these assets are worth something, however, private parties should want to buy them, and they would do so if the owners would accept fair market value. Far more likely is that current owners have brushed under the rug how little their assets are worth.

The bailout has more problems. The final legislation will probably include numerous side conditions and special dealings that reward Washington lobbyists and their clients.

Anticipation of the bailout will engender strategic behavior by Wall Street institutions as they shuffle their assets and position their balance sheets to maximize their take. The bailout will open the door to further federal meddling in financial markets.

So what should the government do? Eliminate those policies that generated the current mess. This means, at a general level, abandoning the goal of home ownership independent of ability to pay. This means, in particular, getting rid of Fannie Mae and Freddie Mac, along with policies like the Community Reinvestment Act that pressure banks into subprime lending.

The right view of the financial mess is that an enormous fraction of subprime lending should never have occurred in the first place. Someone has to pay for that. That someone should not be, and does not need to be, the U.S. taxpayer.

That seemed to be the consensus from the fight over the failed $700 billion bailout bill. As Congress and the Treasury Dept. debated how to fix the mortgage mess, the battle over what caused it took hold.

A prime suspect soon emerged: The government forced banks, lenders and Fannie Mae and Freddie Mac to make loans in poor neighborhoods to meet affordable housing goals and regulations. The loans went bad, setting off the market meltdown.Illustration by: Matt Mahurin

Illustration by: Matt Mahurin

As a measure of how widespread that idea became, House Republicans revolted at an plan to give 20 percent of any government profits from the sale of toxic mortgage securities to affordable housing groups — asserting that ACORN and others like it caused the problem in the first place.

On Sunday, as it reported on the bailout bill negotiations in Congress, Fox News continually explained that ACORN and other community groups pushed for government regulations that caused the foreclosure crisis, citing this Wall Street Journal editorial as a source.

In the end, the proposal for money for housing groups was dropped, confirming that most lawmakers probably agreed with that theory — which has taken hold on the Internet, in conservative circles and in the business press. Last week, Investor’s Business Daily ran a front page story: “How a Clinton-era Rule Rewrite Made Subprime Crisis Inevitable.”

The only problem with all this: it’s completely wrong.Neither the Community Reinvestment Act — the law most cited as the culprit — nor other affordable housing goals set by the government forced Fannie, Freddie or any other lender to make loans they didn’t want to. The lure of the subprime market was high yields and healthy profit margins — it’s as simple as that.

“The rest is a lie — and it’s industry propaganda,” said William Brennan, director of the Home Defense Program of the Atlanta Legal Aid Society, who, in 1991, began raising the alarm over predatory lending in poor neighborhoods. “It’s also racist.”Popular belief now holds that government regulators ordered Fannie and Freddie to buy more loans made to low-income borrowers, and that housing advocates applauded the agencies’ move to enter the subprime market. In fact, the exact opposite is true, Brennan said.

He was among many advocates, back in 2000, who warned that subprime loans were dangerous and decried Fannie and Freddie’s decisions. By purchasing subprime mortgage-backed securities, the two agencies ended up providing capital to predatory lenders — leading to the foreclosures of borrowers Brennan and others saw in increasing numbers coming to them for help.

It makes no sense that housing advocates would have pressured the agencies. They were stuck with cleaning up Fannie and Freddie’s mess.“They weren’t forced to do it,” Brennan said of Fannie and Freddie’s entry into subprime. “They wanted to do it. They were looking at raising their profit margins; and they wanted to please their shareholders.”Everyone’s pointing fingers at Fannie and Freddie now because it’s convenient — they are down and out, seized by the government and they can’t defend themselves, said Guy Cecala, publisher of Inside Mortgage Finance, which follows the subprime industry. It’s all part of larger search for villains in a saga where everyone is guilty, he said.“Basically, everybody’s rewriting history now,” Cecala said. “One thing that’s difficult is that there is no villain when everyone can be blamed.”To Gregory Squires, a sociologist at George Washington University who studies banking practices, the motivation in the blame game is more nefarious. “My guess is that there are some observers out there who view any targeted effort to serve under-served communities as problematic,” Squires said, “and are quick to point to such initiatives today to try to explain away our problems. Better to point to low-income blacks than high-income executives, perhaps.”The main initiative usually cited is the Community Reinvestment Act, a 1977 law that required banks to provide credit to the communities they served. The law was an attempt to offset years of redlining in poor neighborhoods and in minority communities, some of which were middle-to-high income, that had been cut off from conventional credit. In the late 1980s and mid-1990s, the law was strengthened so that banks pursuing mergers or takeovers had to show their compliance with the CRA to get federal approval.In recent months, the idea that the CRA caused the housing crisis took hold, as proponents of the theory argued that lenders were forced to make bad loans to poor borrowers to meet their CRA requirements. That expanded into blaming the poor and minority borrowers, and the community organizers who helped them:

“I always listen to Mark Levin while making Friday night dinner … Funnily enough, he has explained just what it is community organizers do. Advocating, for instance, for affordable housing for the poor — the poor who traditionally rent, because they are bad loan risks. The day that reasoning by banks was junked as “racist,” was the day this crisis became a possibility.,” - Lisa Schiffren, NRO.

But despite its current portrayal as a burdensome regulation, CRA rules were always viewed as loose guidelines within the industry, said Cecala, of Inside Mortgage Finance. Banks were routinely found in compliance with the CRA, and an insider joke among bankers was that you’d have to mug a disabled, elderly, minority homeowner to lose your outstanding CRA rating, Cecala said.Beyond that, as the housing boom grew, so did the number of unregulated mortgage lenders, who made the bulk of subprime loans and who didn’t even have to comply with CRA rules, said John Taylor, president of the National Community Reinvestment Coalition, which represents housing and community development groups. Some 75 percent of subprime loans were made by independent mortgage banks and lenders not covered by the CRA, he said.Taylor’s group met with Federal Reserve Chairman Ben Bernanke last week, and he was “aghast” that the CRA was being fingered as a culprit, Taylor said.“People see an opportunity here, because the economy’s in trouble,” Taylor said. ” The easiest thing to say is, ‘Oh, it was all those poor people.’ It’s easier to try to shift the focus, and to blame the victims and blame the government.”Banks that were making CRA loans profited from them, and they had few complaints, said Squires of George Washington. If they had tried to sell high-rate subprime loans and count them toward their CRA goals, it wouldn’t have worked.

“The CRA explicitly calls for safe and sound lending,” Squires said. “It does not call for lenders to engage in riskier lending than they would normally practice. A few years ago, both the Fed and Treasury conducted studies which found that CRA-related lending was profitable. If a lender is making bad loans, or a compliance officer is encouraging a lender to do so, neither party understands the CRA. That is not the fault of the legislation — but of those who do not understand it.”

When it comes to Fannie and Freddie, there’s also a lot that’s been misunderstood.

The two agencies were created by Congress but privately run, until their takeover. They’ve always had dual missions — to serve their shareholders and increase homeownership.

Like the CRA rules, requirements for either agency to provide affordable housing were pretty loose, Cecala said. At the end of the year, both agencies usually would meet their goals by purchasing some loans for multi-family dwellings, he said. In 2004, the agency that regulated their housing efforts, the U.S. Dept. of Housing and Urban Development, informed both entities they needed to increase affordable housing efforts, with the mortgage market so strong.

But HUD never told Fannie and Freddie to jump into the subprime market. Both chose to dive into subprime mortgage securities, and the purpose wasn’t to satisfy regulators — it was to increase market share, Cecala said. Afterward, they asked HUD if some of the securities they purchased could count toward their affordable housing goals. HUD agreed.

Fannie and Freddie were huge players in the subprime market, buying 48 percent of all subprime-mortgage-backed securities offered in 2004 — way above anything they would ever need to meet affordable housing goals. They continued to buy loans made to multi-family dwellings, as in the past, to satisfy regulators.

Despite claims to the contrary, the two did not rely, for the most part, on subprime securities to meet their regulator’s goals. In any case, the majority of subprime loans were refinancings, which wouldn’t have counted anyway.

“Everybody and their dog had refinanced their prime-rate mortgage” by 2003, Cecala said. And there was no way to make money except by aggressively moving into subprime — meaning it was a business decision by Fannie and Freddie, not a government-mandated one.

The arguments over who caused the crisis go beyond politics alone.

In the last two decades, non-profit community development groups across the country have been making strides in helping increase home ownership among under-served populations - but not through subprime lending. Groups like Manna, Inc. in Washington counseled homeowners through Homebuyer’s Clubs, a support group for borrowers that helped them to clean up credit problems, save for a downpayment and prepare for homeownership.

The default rate on Manna’s prime, fixed-rate loans is zero. There are streets in Washington’s tough Anacostia neighborhood, once abandoned and dangerous, that have been rebuilt entirely by Manna, one house at a time. Banks like working with these groups because it’s profitable for them while it increases homeownership.

That all this success could become sullied by partisanship and finger-pointing worries many housing advocates. “The facts don’t support the people who are trying to undermine fair lending,” NCRC’s Taylor said.

But in the bitter politics of bailing out, the search for a scapegoat is only likely to continue.

The Credit Crisis Could Be Just BeginningJon Markman09/21/07 - 06:40 AM EDTSatyajit Das is laughing. It appears I have said something very funny, but I have no idea what it was. My only clue is that the laugh sounds somewhat pitying.

One of the world's leading experts on credit derivatives (financial instruments that transfer credit risk from one party to another), Das is the author of a 4,200-page reference work on the subject, among a half-dozen other tomes. As a developer and marketer of the exotic instruments himself over the past 30 years, he seemed like the ideal industry insider to help us get to the bottom of the recent debt crunch -- and I expected him to defend and explain the practice.

I started by asking the Calcutta-born Australian whether the credit crisis was in what Americans would call the "third inning." This was pretty amusing, it seemed, judging from the laughter. So I tried again. "Second inning?" More laughter. "First?" Still too optimistic.

Das, who knows as much about global money flows as anyone in the world, stopped chuckling long enough to suggest that we're actually still in the middle of the national anthem before a game destined to go into extra innings. And it won't end well for the global economy.Ursa MajorDas is pretty droll for a math whiz, but his message is dead serious. He thinks we're on the verge of a bear market of epic proportions.

The cause: Massive levels of debt underlying the world economic system are about to unwind in a profound and persistent way.

He's not sure if it will play out like the 13-year decline of 90% in Japan from 1990 to 2003 that followed the bursting of a credit bubble there, or like the 15-year flat spot in the U.S. market from 1960 to 1975. But either way, he foresees hard times as an optimistic era of too much liquidity, too much leverage and too much financial engineering slowly and inevitably deflates.

Like an ex-mobster turning state's witness, Das has turned his back on his old pals in the derivatives biz to warn anyone who will listen -- mostly banks and hedge funds that pay him consulting fees -- that the jig is up.

Rather than joining the crowd that blames the mess on American slobs who took on more mortgage debt than they could afford and have endangered the world by stiffing lenders, he points a finger at three parties: regulators who stood by as U.S. banks developed ingenious but dangerous ways of shifting trillions of dollars of credit risk off their balance sheets and into the hands of unsophisticated foreign investors, hedge and pension fund managers who gorged on high-yield debt instruments they didn't understand and financial engineers who built towers of "securitized" debt with math models that were fundamentally flawed.

"Defaulting middle-class U.S. homeowners are blamed, but they are merely a pawn in the game," he says. "Those loans were invented so that hedge funds would have high-yield debt to buy."The Liquidity FactoryDas' view sounds cynical, but it makes sense if you stop thinking about mortgages as a way for people to finance houses and think about them instead as a way for lenders to generate cash flow and to create collateral during an era of a flat interest rate curve.

Although subprime U.S. loans seem like small change in the context of the multitrillion-dollar debt market, it turns out that these high-yield instruments were an important part of the machine that Das calls the global "liquidity factory." Just like a small amount of gasoline can power an entire truck given the right combination of spark plugs, pistons and transmission, subprime loans became the fuel that underlies derivative securities that are many, many times their size.

Here's how it worked: In olden days, like 10 years ago, banks wrote and funded their own loans. In the new game, Das points out, banks "originate" loans, "warehouse" them on their balance sheets for a brief time, then "distribute" them to investors by packaging them into derivatives called collateralized debt obligations, or CDOs, and similar instruments. In this scheme, banks don't need to tie up as much capital, so they can put more money out on loan.

The more loans that were sold, the more they could use as collateral for more loans, so credit standards were lowered to get more paper out the door -- a task that was accelerated in recent years via fly-by-night brokers that are now accused of predatory lending practices.

Buyers of these credit risks in CDO form were insurance companies, pension funds and hedge-fund managers from Bonn to Beijing. Because money was readily available at low interest rates in Japan and the U.S., these managers leveraged up their bets by buying the CDOs with borrowed funds.

So if you follow the bouncing ball, borrowed money bought borrowed money. And then because they had the blessing of credit-ratings agencies relying on mathematical models suggesting that they would rarely default, these CDOs were in turn used as collateral to do more borrowing.

In this way, Das points out, credit risk moved from banks, where it was regulated and observable, to places where it was less regulated and difficult to identify.Turning $1 Into $20The liquidity factory was self-perpetuating and seemingly unstoppable. As assets bought with borrowed money rose in value, players could borrow more money against them, and it thus seemed logical to borrow even more to increase returns. Bankers figured out how to strip money out of existing assets to do so, much as a homeowner might strip equity from his house to buy another house.

These triple-borrowed assets were then in turn increasingly used as collateral for commercial paper -- the short-term borrowings of banks and corporations -- which was purchased by supposedly low-risk money market funds.

According to Das' figures, up to 53% of the $2.2 trillion of commercial paper in the U.S. market is now asset-backed, with about 50% of that in mortgages.

When you add it all up, according to Das' research, a single dollar of "real" capital supports $20 to $30 of loans. This spiral of borrowing on an increasingly thin base of real assets, writ large and in nearly infinite variety, ultimately created a world in which derivatives outstanding earlier this year stood at $485 trillion -- or eight times total global gross domestic product of $60 trillion.

Without a central governmental authority keeping tabs on these cross-border flows and ensuring a standard of record-keeping and quality, investors increasingly didn't know what they were buying or what any given security was really worth.A Painful UnwindingHere is where the U.S. mortgage holder shows up again. As subprime loan default rates doubled, in contravention of what the models forecast, the CDOs those mortgages backed began to collapse. Because these instruments were so hard to value, banks and funds started looking at all CDOs and other paper backed by mortgages with suspicion, and refused to accept them as collateral for the sort of short-term borrowing that underpins today's money markets.

Through late last month, according to Das, as much as $300 billion in leveraged finance loans had been "orphaned," which means that they can't be sold off or used as collateral.

One of the wonders of leverage is that it amplifies losses on the way down just as it amplifies gains on the way up. The more an asset that is bought with borrowed money falls in value, the more you have to sell other stuff to fulfill the loan-to-value covenants. It's a vicious cycle.

In this context, banks' objective was to prevent customers from selling their derivates at a discount, because they would then have to mark down the value of all the other assets in the debt chain, an event that would lead to the need to make margin calls on customers who are already thin on cash.

Now it may seem hard to believe, but much of the past few years' advance in the stock market was underwritten by CDO-type instruments that go under the heading of "structured finance." I'm talking about private-equity private-equity takeovers, leveraged buyouts and corporate stock buybacks -- the works.

So the structured finance market is coming undone; not only will those pillars of strength for equities be knocked away, but many recent deals that were predicated on the easy availability of money will likely also go bust, Das says.

That is why he considers the current market volatility much more profound than a simple "correction" in prices. He sees it as a gigantic liquidity bubble unwinding -- a process that can take a long, long time.

While you might think that the U.S. Federal Reserve can help prevent disaster by lowering interest rates dramatically, as it did Wednesday, the evidence is not at all clear.

The problem, after all, is not the amount of money in the system but the fact that buyers are in the process of rejecting the entire new risk-transfer model and its associated leverage and counterparty risks.

Lower rates will not help that. "At best," Das says, "they help smooth the transition."

**I can't help but think that we are seeing the start of dark times.**

October 02, 2008, 0:00 a.m.

America’s Nervous BreakdownShould it continue, a world breakdown may follow.

By Victor Davis Hanson

Ancient thinkers from Thucydides to Cicero insisted that money was the real source of military power and national influence. We’ve been reminded of that classical wisdom these last three weeks.

In a manner not seen since the Great Depression, Wall Street went into panic mode from too many bad debts. The symbolic pillars of American monetary strength for years — AIG, Goldman Sachs, Merrill Lynch, Shearson-Lehman, and Washington Mutual — in a matter of hours either went broke, were absorbed, or were reconstituted. Fannie Mae and Freddie Mac collapsed like the house of cards that they were.

Even though the U.S. government rushed to restore trust, hundreds of billions of dollars in paper assets simply vanished. Friends and enemies abroad were unsure whether the irregular American heartbeat was a major coronary or a mere cardiac murmur. How strong — really — was the world’s greatest economy? Was this panic the tab for years of borrowing abroad for out-of-control consumer spending? Had America finally gone too far enriching dictators by buying energy that it either could not or would not produce itself? Had the chickens of lavishing rewards on Wall Street and Washington speculators rather than Main Street producers finally come home to roost?

Allies trust that the United States is the ultimate guarantor of free communication and commerce — and they want immediate reassurance that their old America will still be there. In contrast, opportunistic predators — such as rogue oil-rich regimes — suddenly sniff new openings.

We’ve seen the connection between American economic crisis and world upheaval before. In the 1930s, the United States and its democratic allies — in the midst of financial collapse — disarmed and largely withdrew from foreign affairs. That isolation allowed totalitarian regimes in Germany, Italy, Japan, and Russia to swallow their smaller neighbors and replace the rule of law with that of the jungle. World War II followed.

During the stagflation and economic malaise of the Jimmy Carter years, the Russians invaded Afghanistan, the Iranians stormed our embassy in Tehran, the communists sought to spread influence in Central America, and a holocaust raged unchecked in Cambodia.

It was no surprise that an emboldened Iranian President Mahmoud Ahmadinejad once again last week called for the elimination of Israel. He’s done that several times before. But rarely has he felt brazen enough to blame world financial problems on the Jews in general rather than on just Israelis. And he spouted his Hitlerian hatred in front of the United Nations General Assembly — in New York, just a few blocks away from the ground zero of the Wall Street meltdown.

Flush with petrodollar cash, a cocky Iran thinks our government will be so sidetracked borrowing money for Wall Street that disheartened taxpayers won’t care to stop Teheran from going nuclear.

At about the same time, a Russian flotilla was off Venezuela to announce new cooperation with the loud anti-American Hugo Chavez and his fellow Latin American communists. The move was a poke in the eye at the Monroe Doctrine — and a warning that from now on, the oil-rich Russians will boldly support dictatorships in our hemisphere as much as we encourage democratic Georgia and Ukraine in theirs. Chavez himself called for a revolution in the United States to replace our “capitalist” Constitution.

The lunatics running North Korea predictably smelled blood, as well. So it announced that it was reversing course and reprocessing fuel rods to restart its supposedly dismantled nuclear weapons program.

Meanwhile, some shell-shocked American bankers looked to our “friend” China, which holds billions in American government securities, for emergency loans. But the Chinese — basking in their successful hosting of the Olympics, their first foray into outer space, and a massive rearmament — showed no interest in sending cash to reeling Wall Street firms.

During this Wall Street arrhythmia, Islamic suicide bombers attacked the American embassy in Yemen and the Marriott Hotel in Islamabad, Pakistan. Suspected Islamic terrorists were caught boarding a Dutch airliner in Germany. And suicide bombers were busy again in Afghanistan and Iraq.

The natural order of the world is chaos, not calm. Like it or not, for over a half-century the United States alone restrained nuclear bullies, kept the sea lanes free from outlaws, and corralled rogue nations. America alone could provide that deterrence because we produced a fourth of the world’s goods and services, and became the richest country in the history of civilization.

But the bill for years of massive borrowing for oil, for imported consumer goods, and for speculation has now has finally come due on Wall Street — and for the rest of us as well.

Should that heart of American financial power in New York falter — or even appear to falter — then eventually the sinews of the American military will likewise slacken. And then things could get ugly — real fast.

— Victor Davis Hanson is a senior fellow at the Hoover Institution and a recipient of the 2007 National Humanities Medal and the 2008 Bradley Prize.

Community Reinvestment Act had nothing to do with subprime crisisPosted by: Aaron Pressman on September 29

Fresh off the false and politicized attack on Fannie Mae and Freddie Mac, today we’re hearing the know-nothings blame the subprime crisis on the Community Reinvestment Act — a 30-year-old law that was actually weakened by the Bush administration just as the worst lending wave began. This is even more ridiculous than blaming Freddie and Fannie.

The Community Reinvestment Act, passed in 1977, requires banks to lend in the low-income neighborhoods where they take deposits. Just the idea that a lending crisis created from 2004 to 2007 was caused by a 1977 law is silly. But it’s even more ridiculous when you consider that most subprime loans were made by firms that aren’t subject to the CRA. University of Michigan law professor Michael Barr testified back in February before the House Committee on Financial Services that 50% of subprime loans were made by mortgage service companies not subject comprehensive federal supervision and another 30% were made by affiliates of banks or thrifts which are not subject to routine supervision or examinations. As former Fed Governor Ned Gramlich said in an August, 2007, speech shortly before he passed away: “In the subprime market where we badly need supervision, a majority of loans are made with very little supervision. It is like a city with a murder law, but no cops on the beat.”

Not surprisingly given the higher degree of supervision, loans made under the CRA program were made in a more responsible way than other subprime loans. CRA loans carried lower rates than other subprime loans and were less likely to end up securitized into the mortgage-backed securities that have caused so many losses, according to a recent study by the law firm Traiger & Hinckley (PDF file here).

Finally, keep in mind that the Bush administration has been weakening CRA enforcement and the law’s reach since the day it took office. The CRA was at its strongest in the 1990s, under the Clinton administration, a period when subprime loans performed quite well. It was only after the Bush administration cut back on CRA enforcement that problems arose, a timing issue which should stop those blaming the law dead in their tracks. The Federal Reserve, too, did nothing but encourage the wild west of lending in recent years. It wasn’t until the middle of 2007 that the Fed decided it was time to crack down on abusive pratices in the subprime lending market. Oops.

Better targets for blame in government circles might be the 2000 law which ensured that credit default swaps would remain unregulated, the SEC’s puzzling 2004 decision to allow the largest brokerage firms to borrow upwards of 30 times their capital and that same agency’s failure to oversee those brokerage firms in subsequent years as many gorged on subprime debt. (Barry Ritholtz had an excellent and more comprehensive survey of how Washington contributed to the crisis in this week’s Barron’s.)

There’s plenty more good reading on the CRA and the subprime crisis out in the blogosphere. Ellen Seidman, who headed the Office of Thrift Supervision in the late 90s, has written several fact-filled posts about the CRA controversey, including one just last week. University of Oregon professor and economist Mark Thoma has also defended the CRA on his blog. I also learned something from a post back in April by Robert Gordon, a senior fellow at the Center for American Progress, which ends with this ditty:

It’s telling that, amid all the recent recriminations, even lenders have not fingered CRA. That’s because CRA didn’t bring about the reckless lending at the heart of the crisis. Just as sub-prime lending was exploding, CRA was losing force and relevance. And the worst offenders, the independent mortgage companies, were never subject to CRA — or any federal regulator. Law didn’t make them lend. The profit motive did. And that is not political correctness. It is correctness.

I couldn't source the piece Rachel posted, and the white font made it hard to read about half, but with that said, seeing how evil businessmen are cited the source of the woes I guess it was written by a evening TV drama script writer or their ilk.

Here's another take:

How The Fed, Media And Academia Aided And Abetted Lending Debacle

By STEVEN MALANGA | Posted Wednesday, October 01, 2008 4:30 PM PT

In the early 1990s, I attended a conference designed to teach journalists the tools of an emerging field known as computer-assisted investigative reporting.One of the hottest sessions explained how journalists could replicate stories that other papers had done locally using computer tools, including one especially popular project to determine if banks in your community were discriminating against minority borrowers in making mortgages.

One newspaper, the Atlanta Journal-Constitution, had won a Pulitzer Prize for its computer-assisted series on the subject, and others, including the Washington Post and Detroit Free Press, had also weighed in with their own analyses based on government loan data. Everyone sounded keen to learn if their local banks were guilty, too.

Although academic researchers leveled substantial criticisms against these newspaper efforts (namely, that they relied on incomplete data and did not take into account lower savings rates, higher debt levels and higher loan default rates for many minority borrowers), bank lending to minority borrowers still became an enormous issue — mostly because newspaper reporters and editors in this pre-talk-radio, pre-blogging era were determined to make it so.

Editorialists called for the government to force banks to end the alleged discrimination, and they castigated federal banking regulators who said they saw no proof of wrongdoing in the data.

Eventually the political climate changed, and Washington became a believer in the story. Crucial to this change was a Federal Reserve Bank of Boston study concluding that although lender discrimination was not as severe as suggested by the newspapers, it nevertheless existed.This, then, became the dominant government position, even though subsequent efforts by other researchers to verify the Fed's conclusions showed serious deficiencies in the original work.

For instance, one economist for the Federal Deposit Insurance Corp. who looked more deeply into the data found that the difference in denial rates on loans for whites and minorities could be accounted for by such factors as higher rates of delinquencies on prior loans for minorities, or the inability of lenders to verify information provided to them by some minority applicants.

Ignoring the import of such data, federal officials went on a campaign to encourage banks to lower their lending standards to make more minority loans. One result of this campaign is a remarkable document produced by the Federal Reserve Bank of Boston in 1998 titled "Closing the Gap: A Guide to Equal Opportunity Lending."

Quoting from a study declaring that "underwriting guidelines . . . may be unintentionally racially biased," the Boston Fed then called for what amounted to undermining many of the lending criteria that banks had used for decades:

• It told banks they should consider junking the traditional debt-to-income ratio used by the industry to determine whether an applicant's income was sufficient to cover housing costs plus loan payments.

• It instructed banks that an applicant's "lack of credit history should not be seen as a negative factor" in obtaining a mortgage, though a mortgage is the biggest financial obligation most individuals will undertake.

• In cases where applicants had bad credit (as opposed to no credit), the Boston Fed told banks to "consider extenuating circumstances" that might still make the borrower creditworthy.

• When applicants didn't have enough savings to make a down payment, the Boston Fed urged banks to allow loans from nonprofits or government assistance agencies to count toward a down payment, even though banks had traditionally disallowed such sources because applicants who have little of their own savings invested in a home are more likely to walk away from a loan when they have trouble paying.

Of course, the new federal standards couldn't just apply to minorities. If they could pay back loans under these terms, then so could the majority of loan applicants. Quickly, in other words, these became the new standards in the industry.

In 1999, the New York Times reported that Fannie Mae and Freddie Mac were easing credit requirements for mortgages it purchased from lenders, and as the housing market boomed, banks embraced these new standards with a vengeance.

Between 2004 and 2007, Fannie Mae and Freddie Mac became the biggest purchasers of subprime mortgages from all kinds of applicants, white and minority, and most of these loans were based on the lending standards promoted by the government.

Meanwhile, those who raced to make these mortgages were lionized. Harvard University's Joint Center for Housing Studies even invited Angelo Mozilo, CEO of the lender that made more loans purchased by Fannie and Freddie than anyone else, Countrywide Financial, to give its prestigious 2003 Dunlop Lecture on the subject of "The American Dream of Homeownership: From Cliche to Mission."

Many defenders of the government's efforts to prompt banks to lend more to minorities have claimed that this effort had little to do with the present mortgage mess. Specifically they point out that many institutions that made subprime mortgages during the market bubble weren't even banks subject to the Community Reinvestment Act, the main vehicle that the feds used to cajole banks to loosen their lending.

But this defense misses the point. In order to push banks to lend more to minority borrowers, advocates like the Boston Fed put forward an entire new set of lending standards and explained to the industry just why loans based on these slacker standards were somehow safer than the industry previously thought.

These justifications became the basis for a whole new set of values (or lack of values), as no-down-payment loans and loans to people with poor credit or to those who were already loaded up with debt became more common throughout the entire industry.

What happened in the mortgage industry is an example of how, in trying to eliminate discrimination from our society, we turned logic on its head. Instead of nobly trying to ensure equality of opportunity for everyone, many civil rights advocates tried to use the government to ensure equality of outcomes for everyone in the housing market.

And so when faced with the idea that minorities weren't getting approved for enough mortgages because they didn't measure up as often to lending standards, the advocates told us that the standards must be discriminatory and needed to be junked. When lenders did that, we made heroes out of those who led the way, like Angelo Mozilo, before we made villains of them.

Now we all have to pay.

Malanga is an editor for RealClearMarkets and a senior fellow at the Manhattan Institute.

Rep. Barney Frank (D., Mass.): I worry, frankly, that there's a tension here. The more people, in my judgment, exaggerate a threat of safety and soundness, the more people conjure up the possibility of serious financial losses to the Treasury, which I do not see. I think we see entities that are fundamentally sound financially and withstand some of the disaster scenarios. . . .

Secretary Martinez, if it ain't broke, why do you want to fix it? Have the GSEs [government-sponsored enterprises] ever missed their housing goals?

* * *House Financial Services Committee hearing, Sept. 25, 2003:

Rep. Frank: I do think I do not want the same kind of focus on safety and soundness that we have in OCC [Office of the Comptroller of the Currency] and OTS [Office of Thrift Supervision]. I want to roll the dice a little bit more in this situation towards subsidized housing. . . .

* * *House Financial Services Committee hearing, Sept. 25, 2003:

Rep. Gregory Meeks, (D., N.Y.): . . . I am just pissed off at Ofheo [Office of Federal Housing Enterprise Oversight] because if it wasn't for you I don't think that we would be here in the first place.

Fannie Mayhem: A HistoryA compendium of The Wall Street Journal's recent editorial coverage of Fannie and Freddie.And Freddie Mac, who on its own, you know, came out front and indicated it is wrong, and now the problem that we have and that we are faced with is maybe some individuals who wanted to do away with GSEs in the first place, you have given them an excuse to try to have this forum so that we can talk about it and maybe change the direction and the mission of what the GSEs had, which they have done a tremendous job. . .

Ofheo Director Armando Falcon Jr.: Congressman, Ofheo did not improperly apply accounting rules; Freddie Mac did. Ofheo did not try to manage earnings improperly; Freddie Mac did. So this isn't about the agency's engagement in improper conduct, it is about Freddie Mac. Let me just correct the record on that. . . . I have been asking for these additional authorities for four years now. I have been asking for additional resources, the independent appropriations assessment powers.

This is not a matter of the agency engaging in any misconduct. . . .

Rep. Waters: However, I have sat through nearly a dozen hearings where, frankly, we were trying to fix something that wasn't broke. Housing is the economic engine of our economy, and in no community does this engine need to work more than in mine. With last week's hurricane and the drain on the economy from the war in Iraq, we should do no harm to these GSEs. We should be enhancing regulation, not making fundamental change.

Mr. Chairman, we do not have a crisis at Freddie Mac, and in particular at Fannie Mae, under the outstanding leadership of Mr. Frank Raines. Everything in the 1992 act has worked just fine. In fact, the GSEs have exceeded their housing goals. . . .

Rep. Frank: Let me ask [George] Gould and [Franklin] Raines on behalf of Freddie Mac and Fannie Mae, do you feel that over the past years you have been substantially under-regulated?

Mr. Raines?

Mr. Raines: No, sir.

Mr. Frank: Mr. Gould?

Mr. Gould: No, sir. . . .

Mr. Frank: OK. Then I am not entirely sure why we are here. . . .

Rep. Frank: I believe there has been more alarm raised about potential unsafety and unsoundness than, in fact, exists.

* * *Senate Banking Committee, Oct. 16, 2003:

Sen. Charles Schumer (D., N.Y.): And my worry is that we're using the recent safety and soundness concerns, particularly with Freddie, and with a poor regulator, as a straw man to curtail Fannie and Freddie's mission. And I don't think there is any doubt that there are some in the administration who don't believe in Fannie and Freddie altogether, say let the private sector do it. That would be sort of an ideological position.

Mr. Raines: But more importantly, banks are in a far more risky business than we are.

* * *Senate Banking Committee, Feb. 24-25, 2004:

Sen. Thomas Carper (D., Del.): What is the wrong that we're trying to right here? What is the potential harm that we're trying to avert?

Federal Reserve Chairman Alan Greenspan: Well, I think that that is a very good question, senator.

What we're trying to avert is we have in our financial system right now two very large and growing financial institutions which are very effective and are essentially capable of gaining market shares in a very major market to a large extent as a consequence of what is perceived to be a subsidy that prevents the markets from adjusting appropriately, prevents competition and the normal adjustment processes that we see on a day-by-day basis from functioning in a way that creates stability. . . . And so what we have is a structure here in which a very rapidly growing organization, holding assets and financing them by subsidized debt, is growing in a manner which really does not in and of itself contribute to either home ownership or necessarily liquidity or other aspects of the financial markets. . . .

Sen. Richard Shelby (R., Ala.): [T]he federal government has [an] ambiguous relationship with the GSEs. And how do we actually get rid of that ambiguity is a complicated, tricky thing. I don't know how we do it.

I mean, you've alluded to it a little bit, but how do we define the relationship? It's important, is it not?

Mr. Greenspan: Yes. Of all the issues that have been discussed today, I think that is the most difficult one. Because you cannot have, in a rational government or a rational society, two fundamentally different views as to what will happen under a certain event. Because it invites crisis, and it invites instability. . .

Sen. Christopher Dodd (D., Conn.): I, just briefly will say, Mr. Chairman, obviously, like most of us here, this is one of the great success stories of all time. And we don't want to lose sight of that and [what] has been pointed out by all of our witnesses here, obviously, the 70% of Americans who own their own homes today, in no small measure, due because of the work that's been done here. And that shouldn't be lost in this debate and discussion. . . .

* * *Senate Banking Committee, April 6, 2005:

Sen. Schumer: I'll lay my marker down right now, Mr. Chairman. I think Fannie and Freddie need some changes, but I don't think they need dramatic restructuring in terms of their mission, in terms of their role in the secondary mortgage market, et cetera. Change some of the accounting and regulatory issues, yes, but don't undo Fannie and Freddie.

* * *Senate Banking Committee, June 15, 2006:

Sen. Robert Bennett (R., Utah): I think we do need a strong regulator. I think we do need a piece of legislation. But I think we do need also to be careful that we don't overreact.

I know the press, particularly, keeps saying this is another Enron, which it clearly is not. Fannie Mae has taken its lumps. Fannie Mae is paying a very large fine. Fannie Mae is under a very, very strong microscope, which it needs to be. . . . So let's not do nothing, and at the same time, let's not overreact. . .

Sen. Jack Reed (D., R.I.): I think a lot of people are being opportunistic, . . . throwing out the baby with the bathwater, saying, "Let's dramatically restructure Fannie and Freddie," when that is not what's called for as a result of what's happened here. . . .

Sen. Chuck Hagel (R., Neb.): Mr. Chairman, what we're dealing with is an astounding failure of management and board responsibility, driven clearly by self interest and greed. And when we reference this issue in the context of -- the best we can say is, "It's no Enron." Now, that's a hell of a high standard.

The financial crisis of the past year has provided a number of surprising twists and turns, and from Bear Stearns Cos. to American International Group Inc., ambiguity has been a big part of the story.

Why did Bear Stearns fail, and how does that relate to AIG?

It all seems so complex.

But really, it isn't. Enough cards on this table have been turned over so that the story is now clear. The economic history books will describe this episode in simple and understandable terms: Fannie Mae and Freddie Mac exploded, and many bystanders were injured in the blast, some fatally.

Fannie and Freddie did this by becoming a key enabler of the mortgage crisis. They fueled Wall Street's efforts to securitize subprime loans by becoming the primary customer of all AAA-rated subprime-mortgage pools. In addition, they held an enormous portfolio of mortgages themselves.

In the times that Fannie and Freddie couldn't make the market, they became the market. Over the years, it added up to an enormous obligation. As of last June, Fannie alone owned or guaranteed more than $388 billion in high-risk mortgage investments. Their large presence created an environment within which even mortgage-backed securities assembled by others could find a ready home.

The problem was that the trillions of dollars in play were only low-risk investments if real estate prices continued to rise. Once they began to fall, the entire house of cards came down with them.

Turning point

Take away Fannie and Freddie, or regulate them more wisely, and it's hard to imagine how these highly liquid markets would ever have emerged. This whole mess would never have happened.

It is easy to identify the historical turning point that marked the beginning of the end.

Back in 2005, Fannie and Freddie were, after years of dominating Washington, on the ropes. They were enmeshed in accounting scandals that led to turnover at the top. At one telling moment in late 2004, captured in an article by my American Enterprise Institute colleague Peter Wallison, the Securities and Exchange Commission's chief accountant told disgraced Fannie Mae chief Franklin Raines that Fannie's position on the relevant accounting issue was not even "on the page" of allowable interpretations.

Then legislative momentum emerged for an attempt to create a "world-class regulator" that would oversee the pair more like banks, imposing strict requirements on their ability to take excessive risks. Politicians who previously had associated themselves proudly with the two accounting miscreants were less eager to be associated with them. The time was ripe.

Greenspan's warning

The clear gravity of the situation pushed the legislation forward. Some might say the current mess couldn't be foreseen, yet in 2005 Fed chairman Alan Greenspan told Congress how urgent it was for it to act in the clearest possible terms: If Fannie and Freddie "continue to grow, continue to have the low capital that they have, continue to engage in the dynamic hedging of their portfolios, which they need to do for interest-rate risk aversion, they potentially create ever-growing potential systemic risk down the road," he said. "We are placing the total financial system of the future at a substantial risk."

What happened next was extraordinary. For the first time in history, a serious Fannie and Freddie reform bill was passed by the Senate Banking Committee. The bill gave a regulator power to crack down, and would have required the companies to eliminate their investments in risky assets.

Different world

If that bill had become law, then the world today would be different. In 2005, 2006 and 2007, a blizzard of terrible mortgage paper fluttered out of the Fannie and Freddie clouds, burying many of our oldest and most venerable institutions. Without their checkbooks keeping the market liquid and buying up excess supply, the market would likely have not existed.

But the bill didn't become law, for a simple reason: Democrats opposed it on a party-line vote in the committee, signaling that this would be a partisan issue. Republicans, tied in knots by the tight Democratic opposition, couldn't even get the Senate to vote on the matter.

That such a reckless political stand could have been taken by the Democrats was obscene even then. Wallison wrote at the time: "It is a classic case of socializing the risk while privatizing the profit. The Democrats and the few Republicans who oppose portfolio limitations could not possibly do so if their constituents understood what they were doing."

Mounds of materials

Now that the collapse has occurred, the roadblock built by Senate Democrats in 2005 is unforgivable. Many who opposed the bill doubtlessly did so for honorable reasons. Fannie and Freddie provided mounds of materials defending their practices. Perhaps some found their propaganda convincing.

But we now know that many of the senators who protected Fannie and Freddie, including Barack Obama, Hillary Clinton and Christopher Dodd, have received mind-boggling levels of financial support from them over the years.

Throughout his political career, Obama has gotten more than $125,000 in campaign contributions from employees and political action committees of Fannie Mae and Freddie Mac, second only to Dodd, the Senate Banking Committee chairman, who received more than $165,000.

Clinton, the 12th-ranked recipient of Fannie and Freddie PAC and employee contributions, has received more than $75,000 from the two enterprises and their employees. The private profit found its way back to the senators who killed the fix.

There has been a lot of talk about who is to blame for this crisis. A look back at the story of 2005 makes the answer pretty clear.

Oh, and there is one little footnote to the story that's worth keeping in mind while Democrats point fingers between now and November 4: Senator John McCain was one of the three cosponsors of S.190, the bill that would have averted this mess.

Kevin Hassett, director of economic-policy studies at the American Enterprise Institute, is a Bloomberg News columnist. He is an adviser to Republican Sen. John McCain of Arizona in the 2008 presidential election. The opinions expressed are his own.

This article can also be read at http://www.jpost.com /servlet/Satellite?cid=1222017442844&pagename=JPost%2FJPArticle%2FShowFull

“If your neighbor’s house is burning, you’re not going to spend a whole lot of time saying, ‘Well, that guy was always irresponsible, he always left the stove on, he always was smoking in bed’ … There will be time to punish those who set this fire, but now is the moment for us to come together and put the fire out.”

So says Sen. Barack Obama (D-Ill.) about the Great Financial Crisis. And he’s right. But once the fire is out, I want to learn a lot more about what happened at Fannie Mae and Freddie Mac.

We know that in May 2006, the Office of Federal Housing Enterprise Oversight released a report detailing extensive fraud at Fannie Mae under Franklin Raines, the former Clinton White House budget chief who ran Fannie from 1999 to 2004.

We know that many lawmakers ignored signs of trouble at Fannie and Freddie before that. In a 2004 video now playing on YouTube, California Democratic Rep. Maxine Waters lit into a regulator, saying, “We do not have a crisis at Freddie Mac, and in particular at Fannie Mae under the outstanding leadership of Mr. Frank Raines.”

We know that in 2005, some lawmakers tried hard, but unsuccessfully, to impose discipline on Fannie and Freddie. “If Congress does not act, American taxpayers will continue to be exposed to the enormous risk that Fannie Mae and Freddie Mac pose to the housing market, the overall financial system and the economy as a whole,” said Sen. John McCain (R-Ariz.), a co-sponsor of the Federal Housing Enterprise Regulatory Reform Act of 2005.

And we know that Fannie and Freddie, with significant support on the Hill, stiff-armed all who questioned them. And as they did, they took more and more risks.

He told the panel that in 2006 and 2007, Fannie Mae and Freddie Mac ignored “repeated warnings about credit risk.” In those years, Lockhart said, Fannie and Freddie “bought or guaranteed many more low-documentation, low-verification and non-standard [adjustable-rate] mortgages than they had in the past.”

In the first half of 2007, Lockhart continued, 33 percent of Fannie’s and Freddie’s new business was in funky mortgages — compared to 14 percent in 2005.

That suggests that executives from Fannie and Freddie — and mind you, these were the people who came after Franklin Raines — became more brazen even as they faced harsh assessments from regulators and calls for reform from lawmakers.

And then, it all went to hell. “The capacity to raise capital to absorb further losses without Treasury Department support vanished,” Lockhart testified.

As we come to terms with all this, some lawmakers are facing up to what has happened.

Criticized for his role in that 2004 hearing, Alabama Democratic Rep. Artur Davis released an extraordinary statement to Fox News.

“Like a lot of my Democratic colleagues, I was too slow to appreciate the recklessness of Fannie Mae and Freddie Mac,” Davis said. “I defended their efforts to encourage affordable homeownership, when in retrospect I should have heeded the concerns raised by their regulator in 2004. Frankly, I wish my Democratic colleagues would admit that when it comes to Fannie and Freddie, we were wrong.”

Now, that is a stand-up thing to say.

Davis also sent some blame Republicans’ way, which is surely deserved.

After the fire is put out, there’s going to be a lot more of it.

York is a White House correspondent for National Review. His column appears in The Hill each week. E-mail: byork@nationalreview.com

In alignment with its agenda, the NY Times seeks to share the blame. Is the point fair?

=============

y STEPHEN LABATONPublished: October 2, 2008 “We have a good deal of comfort about the capital cushions at these firms at the moment.” — Christopher Cox, chairman of the Securities and Exchange Commission, March 11, 2008.

As rumors swirled that Bear Stearns faced imminent collapse in early March, Christopher Cox was told by his staff that Bear Stearns had $17 billion in cash and other assets — more than enough to weather the storm.

Drained of most of its cash three days later, Bear Stearns was forced into a hastily arranged marriage with JPMorgan Chase — backed by a $29 billion taxpayer dowry.

Within six months, other lions of Wall Street would also either disappear or transform themselves to survive the financial maelstrom — Merrill Lynch sold itself to Bank of America, Lehman Brothers filed for bankruptcy protection, and Goldman Sachs and Morgan Stanley converted to commercial banks.

How could Mr. Cox have been so wrong?

Many events in Washington, on Wall Street and elsewhere around the country have led to what has been called the most serious financial crisis since the 1930s. But decisions made at a brief meeting on April 28, 2004, explain why the problems could spin out of control. The agency’s failure to follow through on those decisions also explains why Washington regulators did not see what was coming.

On that bright spring afternoon, the five members of the Securities and Exchange Commission met in a basement hearing room to consider an urgent plea by the big investment banks.

They wanted an exemption for their brokerage units from an old regulation that limited the amount of debt they could take on. The exemption would unshackle billions of dollars held in reserve as a cushion against losses on their investments. Those funds could then flow up to the parent company, enabling it to invest in the fast-growing but opaque world of mortgage-backed securities; credit derivatives, a form of insurance for bond holders; and other exotic instruments.

The five investment banks led the charge, including Goldman Sachs, which was headed by Henry M. Paulson Jr. Two years later, he left to become Treasury secretary.

A lone dissenter — a software consultant and expert on risk management — weighed in from Indiana with a two-page letter to warn the commission that the move was a grave mistake. He never heard back from Washington.

One commissioner, Harvey J. Goldschmid, questioned the staff about the consequences of the proposed exemption. It would only be available for the largest firms, he was reassuringly told — those with assets greater than $5 billion.

“We’ve said these are the big guys,” Mr. Goldschmid said, provoking nervous laughter, “but that means if anything goes wrong, it’s going to be an awfully big mess.”

Mr. Goldschmid, an authority on securities law from Columbia, was a behind-the-scenes adviser in 2002 to Senator Paul S. Sarbanes when he rewrote the nation’s corporate laws after a wave of accounting scandals. “Do we feel secure if there are these drops in capital we really will have investor protection?” Mr. Goldschmid asked. A senior staff member said the commission would hire the best minds, including people with strong quantitative skills to parse the banks’ balance sheets.

Annette L. Nazareth, the head of market regulation, reassured the commission that under the new rules, the companies for the first time could be restricted by the commission from excessively risky activity. She was later appointed a commissioner and served until January 2008.

“I’m very happy to support it,” said Commissioner Roel C. Campos, a former federal prosecutor and owner of a small radio broadcasting company from Houston, who then deadpanned: “And I keep my fingers crossed for the future.”

The proceeding was sparsely attended. None of the major media outlets, including The New York Times, covered it.

After 55 minutes of discussion, which can now be heard on the Web sites of the agency and The Times, the chairman, William H. Donaldson, a veteran Wall Street executive, called for a vote. It was unanimous. The decision, changing what was known as the net capital rule, was completed and published in The Federal Register a few months later.

With that, the five big independent investment firms were unleashed.

In loosening the capital rules, which are supposed to provide a buffer in turbulent times, the agency also decided to rely on the firms’ own computer models for determining the riskiness of investments, essentially outsourcing the job of monitoring risk to the banks themselves.

Over the following months and years, each of the firms would take advantage of the looser rules. At Bear Stearns, the leverage ratio — a measurement of how much the firm was borrowing compared to its total assets — rose sharply, to 33 to 1. In other words, for every dollar in equity, it had $33 of debt. The ratios at the other firms also rose significantly.

The 2004 decision for the first time gave the S.E.C. a window on the banks’ increasingly risky investments in mortgage-related securities.

But the agency never took true advantage of that part of the bargain. The supervisory program under Mr. Cox, who arrived at the agency a year later, was a low priority.==============Page 2 of 3)

The commission assigned seven people to examine the parent companies — which last year controlled financial empires with combined assets of more than $4 trillion. Since March 2007, the office has not had a director. And as of last month, the office had not completed a single inspection since it was reshuffled by Mr. Cox more than a year and a half ago.

The few problems the examiners preliminarily uncovered about the riskiness of the firms’ investments and their increased reliance on debt — clear signs of trouble — were all but ignored.

The commission’s division of trading and markets “became aware of numerous potential red flags prior to Bear Stearns’s collapse, regarding its concentration of mortgage securities, high leverage, shortcomings of risk management in mortgage-backed securities and lack of compliance with the spirit of certain” capital standards, said an inspector general’s report issued last Friday. But the division “did not take actions to limit these risk factors.”

Drive to Deregulate

The commission’s decision effectively to outsource its oversight to the firms themselves fit squarely in the broader Washington culture of the last eight years under President Bush.

A similar closeness to industry and laissez-faire philosophy has driven a push for deregulation throughout the government, from the Consumer Product Safety Commission and the Environmental Protection Agency to worker safety and transportation agencies.

“It’s a fair criticism of the Bush administration that regulators have relied on many voluntary regulatory programs,” said Roderick M. Hills, a Republican who was chairman of the S.E.C. under President Gerald R. Ford. “The problem with such voluntary programs is that, as we’ve seen throughout history, they often don’t work.”

As was the case with other agencies, the commission’s decision was motivated by industry complaints of excessive regulation at a time of growing competition from overseas. The 2004 decision was aimed at easing regulatory burdens that the European Union was about to impose on the foreign operations of United States investment banks.

The Europeans said they would agree not to regulate the foreign subsidiaries of the investment banks on one condition — that the commission regulate the parent companies, along with the brokerage units that the S.E.C. already oversaw.

A 1999 law, however, had left a gap that did not give the commission explicit oversight of the parent companies. To get around that problem, and in exchange for the relaxed capital rules, the banks volunteered to let the commission examine the books of their parent companies and subsidiaries.

“We foolishly believed that the firms had a strong culture of self-preservation and responsibility and would have the discipline not to be excessively borrowing,” said Professor James D. Cox, an expert on securities law and accounting at Duke School of Law (and no relationship to Christopher Cox).

“Letting the firms police themselves made sense to me because I didn’t think the S.E.C. had the staff and wherewithal to impose its own standards and I foolishly thought the market would impose its own self-discipline. We’ve all learned a terrible lesson,” he added.

In letters to the commissioners, senior executives at the five investment banks complained about what they called unnecessary regulation and oversight by both American and European authorities. A lone voice of dissent in the 2004 proceeding came from a software consultant from Valparaiso, Ind., who said the computer models run by the firms — which the regulators would be relying on — could not anticipate moments of severe market turbulence.

“With the stroke of a pen, capital requirements are removed!” the consultant, Leonard D. Bole, wrote to the commission on Jan. 22, 2004. “Has the trading environment changed sufficiently since 1997, when the current requirements were enacted, that the commission is confident that current requirements in examples such as these can be disregarded?”

He said that similar computer standards had failed to protect Long-Term Capital Management, the hedge fund that collapsed in 1998, and could not protect companies from the market plunge of October 1987.

Mr. Bole, who earned a master’s degree in business administration at the University of Chicago, helps write computer programs that financial institutions use to meet capital requirements.

He said in a recent interview that he was never called by anyone from the commission.

“I’m a little guy in the land of giants,” he said. “I thought that the reduction in capital was rather dramatic.”

Policing Wall Street

A once-proud agency with a rich history at the intersection of Washington and Wall Street, the Securities and Exchange Commission was created during the Great Depression as part of the broader effort to restore confidence to battered investors. It was led in its formative years by heavyweight New Dealers, including James Landis and William O. Douglas. When President Franklin D. Roosevelt was asked in 1934 why he appointed Joseph P. Kennedy, a spectacularly successful stock speculator, as the agency’s first chairman, Roosevelt replied: “Set a thief to catch a thief.”

The commission’s most public role in policing Wall Street is its enforcement efforts. But critics say that in recent years it has failed to deter market problems. “It seems to me the enforcement effort in recent years has fallen short of what one Supreme Court justice once called the fear of the shotgun behind the door,” said Arthur Levitt Jr., who was S.E.C. chairman in the Clinton administration. “With this commission, the shotgun too rarely came out from behind the door.”==================Page 3 of 3)

Christopher Cox had been a close ally of business groups in his 17 years as a House member from one of the most conservative districts in Southern California. Mr. Cox had led the effort to rewrite securities laws to make investor lawsuits harder to file. He also fought against accounting rules that would give less favorable treatment to executive stock options.

Under Mr. Cox, the commission responded to complaints by some businesses by making it more difficult for the enforcement staff to investigate and bring cases against companies. The commission has repeatedly reversed or reduced proposed settlements that companies had tentatively agreed upon. While the number of enforcement cases has risen, the number of cases involving significant players or large amounts of money has declined.

Mr. Cox dismantled a risk management office created by Mr. Donaldson that was assigned to watch for future problems. While other financial regulatory agencies criticized a blueprint by Mr. Paulson, the Treasury secretary, that proposed to reduce their stature — and that of the S.E.C. — Mr. Cox did not challenge the plan, leaving it to three former Democratic and Republican commission chairmen to complain that the blueprint would neuter the agency.

In the process, Mr. Cox has surrounded himself with conservative lawyers, economists and accountants who, before the market turmoil of recent months, had embraced a far more limited vision for the commission than many of his predecessors.

‘Stakes in the Ground’

Last Friday, the commission formally ended the 2004 program, acknowledging that it had failed to anticipate the problems at Bear Stearns and the four other major investment banks.

“The last six months have made it abundantly clear that voluntary regulation does not work,” Mr. Cox said.

The decision to shutter the program came after Mr. Cox was blamed by Senator John McCain, the Republican presidential candidate, for the crisis. Mr. McCain has demanded Mr. Cox’s resignation.

Mr. Cox has said that the 2004 program was flawed from its inception. But former officials as well as the inspector general’s report have suggested that a major reason for its failure was Mr. Cox’s use of it.

“In retrospect, the tragedy is that the 2004 rule making gave us the ability to get information that would have been critical to sensible monitoring, and yet the S.E.C. didn’t oversee well enough,” Mr. Goldschmid said in an interview. He and Mr. Donaldson left the commission in 2005.

Mr. Cox declined requests for an interview. In response to written questions, including whether he or the commission had made any mistakes over the last three years that contributed to the current crisis, he said, “There will be no shortage of retrospective analyses about what happened and what should have happened.” He said that by last March he had concluded that the monitoring program’s “metrics were inadequate.”

He said that because the commission did not have the authority to curtail the heavy borrowing at Bear Stearns and the other firms, he and the commission were powerless to stop it.

“Implementing a purely voluntary program was very difficult because the commission’s regulations shouldn’t be suggestions,” he said. “The fact these companies could withdraw from voluntary supervision at their discretion diminished the mandate of the program and weakened its effectiveness. Experience has shown that the S.E.C. could not bootstrap itself into authority it didn’t have.”

But critics say that the commission could have done more, and that the agency’s effectiveness comes from the tone set at the top by the chairman, or what Mr. Levitt, the longest-serving S.E.C. chairman in history, calls “stakes in the ground.”

“If you go back to the chairmen in recent years, you will see that each spoke about a variety of issues that were important to them,” Mr. Levitt said. “This commission placed very few stakes in the ground.”

1) Have a fiscal policy that creates immense deficits in good times and bad, burdening America's posterity with staggering burdens of repaying the debt.

2) Eliminate regulation of Wall Street and/or fail to enforce the regulations that already exist, instead trusting Wall Street and other money managers and speculators to manage other people's money with few or no regulations and little oversight.

3) Have an energy policy that disallows producing our own energy and instead requires that we buy energy from abroad, thus making our oil prices highly volatile and creating large balance of payments deficits, lowering the value of the dollar and thus making the problem get progressively worse.

4) Have Congress mandate that banks and other financial entities lend money to persons they know in advance to have poor credit ratings or none at all.

5) Allow investment banks, insurers, and banks to bet their entire net worth and then some on the premise that borrowers known to be improvident will in fact repay those loans.

6) Allow the creation of large betting pools called "hedge funds" that can move markets and control the outcome of trading, thus taking a forum for savings and retirement for families and making it into a rigged casino game that exists primarily to fleece suckers like ordinary working men and women.

7) Have laws that protect corporate officers from being sued for misconduct but at the same time punish lawyers in the private sector who ferret out such misconduct and try to make accountable the people responsible for shareholder and investor losses. If one of those lawyers gets particularly aggressive in protecting stockholders, put him in prison.

Appoint as head of the United States Treasury Department a man whose whole life was spent on Wall Street, who became fantastically rich through his peddling of junk bonds at his firm while the firm later sold short those same sorts of bonds.

9) Scare Americans into putting up $750 billion of their hard earned money to bail out the billionaires and their friends who created the market for loans to poor credit risks (The "subprime" market) and the unbelievably large side bets on those loans, promising that such a bailout would save the retirement savings of Americans, then allow the immense hedge funds to make the market crater immediately afterwards.

10) Propose to save the situation by surtaxing the oil industry, which is owned by our fellow Americans, mostly in their retirement plans, thus penalizing Americans for investing in companies that efficiently and legally produce an indispensable product.

11) Insist that the free market requires that banks and insurers with friends of the Secretary of the Treasury be saved but allow other entities not so fortunate to fail, thus creating total uncertainty and terror among financial institutions, and demolishing all of the confidence built up in financial circles since the days of FDR.

12) Then have the Republican candidate say he would keep on the job the Treasury Secretary who facilitated the crisis, failed to protect the nation from the crisis, got the taxpayers to pony up to save his Wall Street buddies, and have the Democratic candidate, as noted, say he would save the day by taxing the stockholders of energy companies.

Maybe I didn't hear correctly tonight, but I thought McCain (Republican) said that we need to buy up mortgages and re-price them to their current much lower market value. I don't get it; I and most of my friends bought a house and put 20% down. We worked hard for this deposit and have worked hard to made our payments ever since, but it's not always easy. You crimp and save, and somehow make it happen. So I don't quite understand why the Republican Party (fiscal conservatives?) is going to give a free ride to someone who buying a house put near or nothing down, bought a house that logic says they can never now or ever will afford, and now you are going to forgive a large portion of their debt? So they can live in a house that they never should have bought, had no business buying, nor could have afforded in the first place? How about the people who are financially responsible? With our tax dollars we are suppose to pay for this free ride? I must be missing something here. Maybe I should go buy a Ferrari on borrowed money; maybe the government will re-price my loan and give me a free ride when the dealer figures out I can't afford the payments. Cool.

The WEEK magazine (link embedded) offers a brief, but excellent, primer on the derivative securities that caused, and cause, the maelstrom on Wall Street.

Briefing: Wall Street’s hidden time bombs

The financial meltdown engulfing Wall Street would not have happened without the advent of complex financial contracts known as derivatives. Why were they created, and why were so many supposedly smart people fooled?

What is a derivative?

In a very real sense, it’s a bet. A derivative is a contract in which an investor agrees to pay for either a commodity or financial instrument at a set price today, in return for the right to take profits if that asset’s value rises. Some derivatives, such as stock options and commodities futures, have been used for years and are considered completely benign. A farmer, for example, can agree to sell a ton of wheat he’ll harvest in three months to a major grain buyer for $1,000. That deal enables the farmer to lock in the price of wheat as he’s growing it. In exchange for that guarantee, the grain buyer gets an assurance he’ll have a steady supply of grain while also safeguarding against future price increases. Both sides, in other words, reduce risk and future uncertainties. But in recent years, a new, highly toxic form of financial derivative has spread like wildfire throughout the financial system, ultimately laying waste to some of Wall Street’s oldest and most prestigious firms.

What are these new derivatives?

They’re called credit derivatives, and were designed to serve as a kind of insurance against borrowers defaulting on their debts. Credit derivatives first appeared on the scene in the boom of the 1990s, but really became popular in the early 2000s, when Federal Reserve Chairman Alan Greenspan sought to stave off a post-9/11 recession by slashing interest rates from 6.5 percent to 1 percent. Money became very easy to borrow, and tens of millions of people bought homes or took out second mortgages, many of which were offered to financially shaky buyers at “subprime’’ rates. Those mortgages were then bundled into securities, and firms such as Lehman Brothers and Merrill Lynch created credit derivatives to protect investors in case the securities defaulted.

Why were these securities so popular?

They provided above-market rates of return, and because these complex instruments were so poorly understood, they seemed more solid—and less risky—than they really were. Investors thought that they were getting AAA-rated securities. The sellers—caught up in the assumption that housing prices would continue to rise indefinitely—also thought they were safe from losses. Each security involved hundreds or thousands of individual mortgages, chopped into pieces, so that the risk of default appeared small. And by selling them, investment banks and brokerage firms made hundreds of millions in upfront fees and premium payments. That’s why global insurance giant AIG also jumped into the derivatives game. “It is hard for us, without being flippant, to see us losing even one dollar in any of those transactions,” Joseph Cassano, then AIG’s head of credit derivatives, declared last year, expressing a common sentiment.

Was everyone so clueless?

No. Concern about financial derivatives first surfaced in the late 1990s, and congressional Democrats launched a drive to bring them under federal oversight. The effort was beaten back by Republicans led by then­–Sen. Phil Gramm of Texas, who pushed through a law that explicitly exempted financial derivatives from federal regulation. By 2003, the pace of derivatives trading had exploded, leading Warren Buffett, one of the world’s most successful investors, to call derivatives “financial weapons of mass destruction.”

Why was Buffett alarmed?

Because the well-being of the entire global financial system rested in part on a hidden world of multitrillion-dollar bets that financial regulators couldn’t control or even monitor. Indeed, since 2000, credit default swaps became one of Wall Street’s most popular products, with firms such as AIG, Lehman Brothers, and Bear Stearns selling swaps covering trillions of dollars in bonds. At Cassano’s urging, AIG became the biggest player in the field, selling protection on $527 billion in bonds.

So what went wrong?

Home prices started to fall and interest rates started to rise. When rates rose, many subprime borrowers with adjustable-rate mortgages found themselves unable to make their monthly payments. They also couldn’t sell, because the demand for houses began to crash. Very quickly, as defaults mounted, the derivatives that had made so many bankers and investors rich lost their value. In turn, firms such as AIG and Lehman, which had guaranteed these securities, couldn’t meet their debts. It was a worst-case scenario, causing the collapse of many banks and investment firms. Despite the federal government’s rescue efforts, many financial executives worry that further damage is yet to come, because of bad debt hidden in other banks’ derivative holdings. “It’s not the corpses you can see that scare you,” says one Wall Street banker. “It’s the corpses you can’t see that could pop out at any time.”

Can derivatives be brought under control?

Washington and Wall Street are struggling to find a way. One of the most popular ideas is to set up a clearinghouse for all financial derivatives trades. Regulators would monitor the clearinghouse to be sure that no market player took on more risk than it could afford. And firms would have to keep money on deposit to show that they could honor their guarantees. The question now is whether safeguards can be put in place before another AIG-style meltdown unfolds. “If it all goes horribly wrong, it will not be just Wall Street that suffers,” says veteran investor Michael Panzer, who has warned against derivatives for years. “Those seeking a mortgage, a college education, a job, or even day-to-day sustenance will be left wanting.”

The derivatives in your portfolioIf some of your savings are in a mutual fund, you’re probably an investor in derivatives. Many bond funds, including the nine most widely held funds, use derivatives both to protect against losses and to increase returns, because these swaps can appreciate in value when the prospects for a company and the overall economy improve. Funds aren’t required to disclose derivatives holdings, although those that make them a major part of their strategy typically do so. To see if your fund holds derivatives, check its prospectus and the listing of holdings contained in Securities and Exchange Commission form NQ. Those forms can be accessed at http://www.sec.gov/. If you’re still unsure about your fund’s holdings and don’t want to take the chance, financial advisors say, don’t hesitate to switch to an ultra-safe government bond fund. “Don’t be complacent,” says financial advisor Lawrence Glazer. “If you are uncomfortable with something, don’t be afraid to make a change.”

Interesting video, linked below, about the perverse incentives embodied in the bailout.

What You Need to Know About the Bailout (and Why You Should Be Really Worried)

Nick Gillespie | October 8, 2008, 9:05am

George Mason University economist and author Russell Roberts, who blogs at the always interesting Cafe Hayek, sat down with reason.tv to talk about the nation's shakey economy and the government's bailout plan. Watch this six-minute interview to learn where the problems came from, why the bailout won't address them, and what sort of hurt we're in for over the next several weeks, months, and years. "The real cost of this," warns Roberts, "is that we have said to people, 'Risk taking is not as risky as it used to be.' That's a mistake. It's a horrible mistake and it will lead to a lower standard of living down the road because investment will be more cavalier and less prudent."

NEW YORK (CNNMoney.com) -- Under a mortgage rescue plan announced at the debate Tuesday night by Senator John McCain, much of the burden of paying to keep troubled borrowers in their homes will shift to taxpayers.

McCain's original plan called for lenders to write down the value of these mortgages, and take those losses. McCain unveiled the new $300 billion plan in response to the first question of the debate.

He said, "I would order the Secretary of Treasury to immediately buy up the bad home loan mortgages in America and renegotiate at the new value of those homes, at the diminished values of those homes, and let people make those - be able to make those payments and stay in their homes."

The government would convert failing mortgages into low-interest, FHA-insured loans.

"Millions of borrowers" would be eligible for the program, dubbed the American Homeownership Resurgence Plan, according to McCain economic advisor, Doug Holtz-Eakin.

To qualify, homeowners would have to be delinquent in their payments already, or be likely to fall behind in the near future. They would have to live in the home in question - no investment properties would be eligible - and have had demonstrated their credit-worthiness when they purchased the property by putting down a substantial down payment and by providing documentation of their income and assets - no liar loans.

Holtz-Eakin said on a conference call Wednesday that the McCain plan could be put into place quickly because the groundwork and the authority for it has already been provided by last week's $700 billion bailout bill, the Hope for Homeowners program authorized by the housing rescue bill passed in July, and the government takeover of mortgage giants Fannie Mae and Freddie Mac.

This proposal is strikingly different from both McCain's original idea, and from the housing rescue bill adopted by Congress in July.

Congress struggled for months to pass the Hope for Homeowners rescue plan for mortgage borrowers. To make it palatable to both conservative Republicans and ordinary taxpayers, Hope for Homeowners requires that lenders write down mortgage balances to 90% of a home's the current market value it they could qualify for a FHA-insured refinancing. The lenders would then take the loss on the difference between the current value and the mortgage balance.

"[McCain's] original plan relied on lenders taking the hit," said Holtz-Eakin. "This bypasses that step."

Instead, taxpayers pay for it, under the funding already provided by the $700 billion bailout bill.

I didn't know that; it was my understanding that Obama's position was that of McCain's before the debate, the loans should be bought up and that the lender's (the lenders were in the risk business) should be responsible for the loss, not the taxpayers. But maybe I am wrong? If you are right then I am upset at both of them.

While I may be a social liberal, I am a financial conservative. But even if you are right, one of the reasons I vacillate between McCain and Obama is that I thought McCain, the Republicans, wouldn't give away the store and charge the taxpayer and reward individuals for their reckless spending and reward the lenders for failure. What you sow is what you reap; seems fair to me. Lately, I am having my difficulty differentiating between Democrat and Republican. They both seem to be pandering and rushing to give away money.

As I understand it, McCain and Obama's plans are essentially the same, so I guess the same measure of opprobrium should be addressed to each?

Maybe not.

updated 3 hours, 12 minutes ago

McCain faces conservative backlash over mortgage planSTORY HIGHLIGHTSGOP candidate meets resistance from within own party on mortgage planMcCain proposes government buying and refinancing bad mortgagesEditorial: Plan a "gift to lenders who abandoned any sense of prudence" McCain hopes plan will resonate with moderate and undecided votersNext Article in Politics »

By Alexander Mooney CNN

(CNN) -- John McCain is facing a fresh round of anger from members of his own party deeply opposed to the Arizona senator's proposal for the federal government to purchase troubled mortgage loans.

John McCain first mentioned his mortgage relief plan during Tuesday's town-hall debate with Barack Obama.

The pointed backlash from several economic conservatives -- many of whom already distrust McCain's commitment to free-market principles -- couldn't come at a worse time for the Republican presidential nominee less than four weeks before Election Day as he stares at a significant deficit in national and state polls.

But at a time when McCain can't afford to worry about a lack of support from his party's base, several conservatives are openly criticizing the plan as a flagrant reward for reckless behavior among lenders.

In a sharply worded editorial on its Web site Thursday, the editors of The National Review -- an influential bastion of conservative thought -- derided the plan as "creating a level of moral hazard that is unacceptable" and called it a "gift to lenders who abandoned any sense of prudence during the boom years." Watch the candidates' plans get the 'no bull' test »

Matt Lewis, a contributing writer for the conservative Web site Townhall.com, told CNN the plan only further riles conservatives upset with McCain's backing of the massive government bailout plan passed last week.

"Fundamentally, the problem is John McCain accepts a lot of liberal notions, unfortunately. There is somewhat of a populist streak," he said. "Most conservatives really did not like the bailout to begin with, and this was really kind of picking at the scab."

Don't MissBush to try again to reassure nationObama: McCain plan shows 'erratic' leadershipBorger: McCain running out of time, linesEconomic worries tipping Wisconsin toward ObamaIt's not just the plan conservatives are unhappy with, but how it was first unveiled as well -- out of the blue at Tuesday's town-hall debate during which Republicans were instead hoping McCain would present a spirited attack on what they view as Obama's overly liberal positions.

"Here we are watching the debate hoping this is a good format for John McCain to excel at, and the first thing he does is spring this on us," Lewis said. "This is not a good way to win friends and influence people."

"He spent the entire debate assailing massive government spending -- while his featured proposal of the right was to heap on more massive government spending to pursue home ownership retention at all costs," Malkin said.

It's a proposal that is fundamentally at odds with the conservative principle of individual responsibility, and is the latest in a string of public spats conservatives have had over the years and in this election with their party's standard bearer.

But for McCain, the move is another gamble for a candidate in need of a game-changer and one that lends credence to the self-proclaimed maverick's repeated claim that he's unafraid of bucking his own party.

Under the plan, the government would buy up bad mortgage loans, converting them into low-interest, FHA-insured loans. To qualify, homeowners would have to be delinquent in their payments or be likely to fall behind in the near future.

They also would have to live in the home in question -- no investment properties would be eligible. They would need to have demonstrated their creditworthiness when they purchased the property by making a substantial down payment and by providing documentation of their income and other assets.

McCain economic adviser Douglas Holtz-Eakin said on a conference call Wednesday that the McCain plan could start quickly because the authority was granted by last week's passage of the $700 billion economic bailout bill. The plan could also fall under the umbrella of the Hope for Homeowners program authorized by the housing rescue bill passed in July and the government takeover of mortgage giants Fannie Mae and Freddie Mac.

But the plan, which the McCain campaign appeared to be finalizing even after the candidate announced it, significantly departs from the Arizona senator's original proposal and has left many conservatives scratching their heads:

"The original plan relied on lenders taking the hit," Holtz-Eakin said on the conference call. "This bypasses that step."

Instead the estimated $300 billion tab essentially gets transferred to taxpayers, among the funding already provided by the bailout bill -- a proposal that may rile not only fiscal conservatives, but also struggling homeowners who have worked to keep up their mortgage payments.

"The guy who works two jobs and struggles to actually pay his mortgage is penalized. He would be better off under this plan to just quit paying his mortgage," Lewis said. "And this fundamentally goes against a lot of conservative principles and individual responsibility."

This was my point I was trying to make it goes against individual responsibility! And Body-by-Guiness; note in the next sentence even Obama comments that McCain's Plan goes beyond the Democratic Plan and that the taxpayers will lose and lenders will be rewarded.

Barack Obama is counting on McCain's proposal not playing well with a broad swath of middle-class voters. Obama said at a rally Thursday morning it guarantees "the taxpayers would lose," and banks and lenders would be rewarded.

But McCain is hoping the plan will resonate with moderate and undecided voters, many of whom viewed the bailout as a giveaway to Wall Street CEOs. This plan, the McCain campaign argues, better steers the money to Main Street, where struggling homeowners need immediate relief.

"John McCain's plan represents absolutely no new expense to the taxpayer, but simply refocuses priorities to more directly assist the homeowners who are hurting instead of greed on Wall Street," said Tucker Bounds, a spokesman for the McCain campaign.

But it remains to be seen if the Arizona senator's latest roll of the dice will pay off.

"Liberals who might actually be inclined to support a welfare check such as this are already going to vote for Barack Obama, and conservatives, who view this as irresponsible and even apostasy, are turned off by it," Lewis said. "This is both bad policy and bad politics." E-mail to a friend | Mixx it | Share

"Pathetic unprincipled populist pandering by McCain as he tries to poach on BO's natural turf. It is no coincidence that he is diving in the polls"

I agree with you but this is how elections in the US in 2008 are won.We have a gigantic class of people who rely on government, many who work for government, and have who increasing power at the polls.It appears the only other option Repubs have had is to go negative and try to scare this gigantic "what are you (gov.) going to do for me" segment of our populous away from the Crat candidates who promise to rob the successful to give to them.

We have the credit crunch and we have the stock (and real estate) sell-offs. Therefore one caused the other??? Not necessarily. I would add in the other development of the day, that Democrats are about to take over the House, Senate - perhaps the magic 60 vote senate, the Presidency (and of course the Supreme Court).

Obama isn't going to lower marginal tax rates for anyone as near as I can tell. He just going to 'let' some keep their Bush tax cut, but not for the people he thinks are "rich" enough already.

Obama IS going to dramatically raise the capital gains tax rate, so you are now RICH if you have investments you ever want to sell.

Obama is also hellbent on keeping our tax rate on employers at the second highest rate of the developed world. For a basketball player, you would think he would shy away from having his team compete with heavy ankle weights.

Soaking the rich sounds great unless you happen to share an economy with them.

Let's say you are 'rich' and you know that Democrats are taking over government next year. You know they will double or at least increase significantly the tax rate on capital gains next year depending on which version of the Obama tax plan you think is the real one. What would you do? What should you do???

First thought would be to to sell off your assets on the last day before the rate increase goes into effect. But that isn't good enough because everyone else will sell off their assets first - as soon as they smell an electoral victory for the party who wants to punish wealth and achievement. So if you want to sell off your assets - real estate, stocks, whatever, you need to get to the front of the line and sell faster, harder and sooner than the other investors, before the values plummet from the rush to sell.

So, how is your 401k looking as regime change in America starts to take shape?

Blame it all on Bush if you want but investment decisions are based on the outlook for future, AFTER-TAX returns, not on the past. As Obama's election goes from possible to certain, all I see is a mad rush of investors to the exit. And they all got ahead of me! The only real question is - why are we all so surprised???

Are there more small business owners than government employees, union people, and citizens who rely on government doles (or want more thereof) and immigrants who come in a jump on the dole bandwagon (of course not all of them - but enough)? I doubt it. McCain is preaching to the minority. BO is preaching to the majority. End of story.

I just don't think simply saying we need to cut taxes is enough with BO out there preaching his lies for months with "I am cutting taxes for 90% of the folks in this country". I have yet to hear McCain or anyone else come out with enough of a response to that simple line that is going to turn the undecideds from the BO. I did hear Dick Morris fianlly say something to this effect on O'Reilly the other night. Whatever one wants to say about him, he is very nimble at adjusting the arguments to the polls. McCains advisors or perhaps McCain himself still have not gotten it.The BO campaign has done a MUCH better job of responding to and countering the Repubs arguments than the other way around.

Are there more small business owners than government employees, union people, and immigrants who come in a jump on the dole bandwagon (of course not all of them - but enough)? I doubt it. McCain is preaching to the minority. BO is preaching to the majority. End of story.

McCain either better have a great case to squash the "I am going to cut taxes for 90%", and "what has been done for the last eight years is not working" arguments in this last debate or it is definitely over.

According to economic analysis the severe financial crisis ravaging the US and hitting the international community on all continents has its economic roots in two major realms: One was the overbearing political pressure put on Wall Street to release loans into unprepared sectors of society and two, was the miscalculation -some say the drunkenness- of Wall Street in accepting these immense risks. But according to Political Economy assessment, there may have been a third player in the crisis: OPEC, or more precisely, radical circles within Oil Producing regimes in the Peninsula. The thesis argue that combined Salafist-Wahabi and Muslim Brotherhood circles in the Gulf -with consent from the Iranian side on this particular issue, used the escalating pricing of Oil over the past year to push the financial crisis in the US over the cliff. The “high point” in this analysis is the timing between the skyrocketing of the prices at the pumps and the widening of the real estate crisis. In short the “Oil-push” put the market out of balance hitting back at Wall Street. Basically, there was certainly a crisis in mismanagement domestically (with its two above mentioned roots), but the possible OPEC economic “offensive” crumbled the defenses of US economy in few months.

The link between this analysis and our counter terrorism interests is dual. One, if the forthcoming investigation will demonstrate that there was a war room manipulated by the “radicals” within OPEC striking at US and Western economies, we would be witnessing the rise of the concept of “economic terrorism.” Two, and as the forthcoming investigation is progressing, a re-reading of al Qaeda and other Jihadi literature, speeches and statements about the Silah al Naft (Weapon of Oil) and more particularly the calls by Ayman Zawahiri on “selling US dollars and buying Gold, ahead of American economic collapse” seems to be necessary. Zawahiri’s statements most likely aren’t coordinated with the OPEC “hard core” push but his knowledge of the “push” is more than likely because of his ties to the Wahabi-Salafi circles inside the Kingdom. Moreover, such a finding would shed light on the analysis of commentary on the web and on Satellite media about "the necessity for Americans to feel the pain of economic pressures, to put political pressures on their Government to change course in the region."

I am posting here two pieces on the subject.

Is There A Foreign Force Waging War Against the US Economy? (Part One)

Dr. Walid Phares

In the fog of economic mayhem ravaging American and international economies, experts are having a hard time determining the root causes of the current financial crisis. One parameter is established: The Ground Zero of this economic fear is located in Wall Street, a few blocks away from the other Ground Zero, where al Qaeda destroyed the World Trade Center and massacred thousands of Americans and other nationals.

While we know who caused the destruction of the twin towers and why they did it, the question of who is causing the crumbling of the world economy, starting with America, and why, remains unanswered. It will take probably years and the best economists to investigate the web that led to the most dangerous crisis in international finance since the late 1920s. But to political economists and international relations analysts, there are some leads to explore while pure economists are proceeding with only their reconstruction of the crisis.

The latter may not ever reach definitive conclusions, and for political reasons. Too many strategic interests are at stake in the convulsions we are witnessing. From a stratospheric view, we see a US economy bleeding intensely; and as its government, in the midst of an electoral transition, is trying to administer some financial medicine, we can see that serious illnesses are breaking out in several economies around the world. The international community is waking up to watch another dimension of globalization: the lethal domino effect. When the greatest economy goes down, the international economic system follows.

But strategic analysts cannot avoid asking the following questions: Was the crisis system-induced or was it provoked or at least helped to spread? The main answer is found in the American genesis of the collapse. In sum, experts say, a huge mismanagement by both Wall Street and Washington ended up flooding Main Street with loans impossible to pay back. The mechanisms of the problem seem to be simple: American bankers and lenders messed up. They overestimated the ability of the markets to absorb these monies destined to help small consumers to leap into a higher social level, and to return their loans on time. And since millions of real estate buyers weren’t actually able to afford what they bought, the financial tidal wave hit back at the banking institutions, crumbling them. And as the financial giants were falling on Wall Street, a Tsunami was unleashed on all continents, hitting monetary institutions from Tokyo to London. This equation - in a micro nutshell - is the official story of the beginnings of the crisis, but certainly not the end of it.

As we continue to watch the economic spasms, we proceed along another line of basic questions. Other than raw capitalist greed, why did the lenders initially increase their offers into the markets? Who or what led the flood of cash? Many argue that the trend of pushing out-of-control loans to unqualified segments of society emanated from political operatives on the Left. Meaning that pressure groups, including national politicians, induced Wall Street to cross the fine line of appropriate banking policy to grant almost any loan seeker, regardless of his capacity to pay back the mortgage loan. But even if that were true, market analysts would have figured out the weaknesses of such a plan. So the next question is: on what grounds was the huge release of funds rationalized?

One answer could be that an assumption was made that jobs would always provide income for the payments of such mortgages. So, up to this stage, blame can be leveled in two directions. First, towards those politicians who threatened political retaliation if the financial system didn’t lend beyond rational limits; and second, Wall Street financiers who risked breaking the financial system by relying on poor judgment regarding the public’s ability to overcome economic challenges. Economists and those investigative committees expected to be formed will tell us more about the American roots of this economic debacle.

A thorough psycho-economic observation of the public’s financial behavior, however, tells us that there may be more to the crisis. It reveals that an outside “push” - I now coin it economic terrorism - may have been the tipping point of the collapse. For monitoring how and why buyers massively abandoned their plans shows that it followed, or coincided, with an abrupt rise in the cost of gas dividends. With the numbers at the pumps going ballistic, the cost of living suddenly rose, goods became less attainable and the price of enjoying, let alone using, the newly purchased properties soared. Hence, undoubtedly the lifestyle that was sought by the tens of millions of homes buyers wasn’t possible to achieve anymore; thus they surrendered financially in droves, taking the system down with them.

Economists will tell us if this diagnosis stands up. But if it does, then we cannot avoid investigating the factor that caused the strategic stress in real estate, which turned into economic chaos. In bypassing a narrow economic analysis, we can detect clearly the connection between the dizzying ups in petrol pricing and the slowing of American buying capacity. Stunningly, one can conclude that while it is sadly true that both Wall Street’s corruption and politicians’ abuse of the system handed the tools of doom to the middle class, Main Street’s rapid disenfranchisement was manufactured overseas, thousands of miles away, at the hands of OPEC, or perhaps in some quarters of the oil-producing Cartel.

Indeed, as economic commentators tell us (including a strong accusation leveled by real estate tycoon Donald Trump on Fox News against OPEC), oil powers are behind the instability that crumbled the will of millions of middle class Americans over the past three years. If we go back in time, we can see that oil pricing by OPEC’s hard core shows clearly that US leadership wasn’t able to convince the top producers from the Gulf to give American oil consumers a chance. Most producing regimes replied that demand - mostly from China and India - was putting pressure on production. Pressed by Washington to produce more, the “regimes” alleged it would affect the selling price and thus minimize their profits, but promised they would try to “be understanding” of US needs in energy.

This attitude gave the producers discretion over price, while Jihadi propagandists roamed the media accusing Washington of putting unbearable pressure “on the region” to follow American injunctions in setting petrol’s prices. Was there a connection between the oil regimes and the Jihadi propagandist machine? We have no answer to that now, but clearly an oil strategy was in the works with a calculated impact on the US economy. This charge is still in its early stages, it will be challenged ferociously, but it will stand as long as limpid answers are not provided. Dr. Walid Phares is the Director of the Future Terrorism Project at the Foundation for the Defense of Democracies and a visiting scholar at the European Foundation for Democracy. He is the author of The Confrontation: Winning the War against Future Jihad.

Who manufactured the financial meltdown? It wasn’t only Wall Street: OPEC’s heavy hand is felt but unseen by the media and our politicians.

In bypassing a narrow economic analysis of the ongoing crisis, we can detect clearly the connection between the dizzying ups in petrol pricing and the slowing of American buying capacity. Though we have to conclude that while it is due largely to both Wall Street’s corruption and politicians’ abuse of the system handed the tools of doom to the middle class, Main Street’s rapid disenfranchisement was manufactured overseas, thousands of miles away, at the hands of many of the members of OPEC, the oil-producing Cartel.

Indeed, as economic commentators tell us (including a strong accusation leveled by real estate tycoon Donald Trump on Fox News against OPEC), the oil powers are behind the instability that crumbled the will of millions of middle class Americans over the past three years.

If we go back in time, we can see that oil pricing by OPEC’s hard core shows clearly that US leadership wasn’t able to convince the top producers from the Gulf to give American oil consumers a chance. Most producing regimes replied that demand -- mostly from China and India -- was putting pressure on production. Pressed by Washington to produce more, the “regimes” alleged it would affect the selling price and thus minimize their profits, but promised they would try to “be understanding” of US needs in energy.

This attitude gave the producers discretion over price, while Jihadi propagandists roamed the media accusing Washington of putting unbearable pressure “on the region” to follow American injunctions in setting petrol’s prices. Was there a direct connection between the oil regimes and the Jihadi propagandist machine? We have no answer to that now, but clearly an oil strategy was in the works with a calculated impact on the US economy. This charge is still in its early stages, it will be challenged ferociously, but it will stand as long as convincing answers are not provided.

What adds to the inquiry into the OPEC destabilization factor are the many indicators that strategic political motives have appeared to be behind the pricing maneuvers. Over a period of half a decade, many voices heard on the region’s airwaves have intimated that the US economy will be made to pay for what America’s leadership is doing. Commentators, some funded by oil producers on several outlets including on al Jazeera, underlined that as long as average citizens in the United States (and eventually in the West) don’t feel financial pain, the war on terror and spreading of Democracy won’t be stopped.

Sheikh Yussuf al Qardawi, Muslim Brotherhood ideologue and mentor of the Qatari-funded channel, spoke openly of Silah al Naft, i.e, “the weapon of oil.” Indeed, it was called a weapon - as in a warfare situation -- and most likely it was used as such. Of course, the producing “regimes” will deny the existence of a real strategy to bring the US to its knees by striking at its pumps. They will dismiss statements made by emirs and commentators in this regard. The “field Jihadists”, however, won’t deny the existence of such a battlefield.

For years now, Salafist web sites and al Qaeda spokespersons have loudly called for an “oil Jihad against infidel America and its lackeys.” Online material is still circulating. But more revealing are the official speeches by Osama Bin Laden and his deputy on the “absolute necessity to use that weapon.”

Ayman Zawahiri called expressly and repetitively on the public to sell their US dollars and buy gold instead (Be’u al dullar washtaru al zahab). These were stunning statements ignored by most analysts at the time but that are making sense today. He predicted a collapse in the infidels’ economy, starting from American markets. Was he a part of the lobbying effort in the OPEC game? Most likely not, but he seems to have been privy to the game, having insiders in the Wahhabi radical circles in the Peninsula: in the end there are too many political signs to dismiss and the analysis of price warfare is too evident to ignore.

OPEC’s manipulation of the markets did hit Americans hard in their pockets. Hundreds of millions of John and Jane Does were intimidated, terrorized really, into abandoning their lifelong dreams of owning properties because of the aggressive stance of petro-regimes towards the US and its campaign to spread democracy in the Greater Middle East. In historical terms, America was punished for daring to change the status quo in the Arab and Muslim world to the advantage of the weakest and the suppressed: Shia and Kurds in Iraq, Syrian reformers, Lebanese civil society, Africans in Darfur, Iranian women and students, artists and liberals across the Arabian Peninsula. In return, the U.S was submitted to economic destabilization, steady, gradual and by small doses.

Let’s not underestimate the power of the Jihadi-oil lobby in America: it has decades of influence and it has long arms into the system, and it has powerful political allies. It knows when Americans are messing up their own system, and it knows very well how to push them over the cliff, into the abyss of economic calamity.

A counterpoint to this thesis would vigorously argue that the alleged OPEC destabilization over the US economy is illogical, as many countries in the Gulf are experiencing a recession as a result of Wall Street’s crunch. In other words, they wouldn’t do it to themselves. Yet the ideological forces manning the oil weapon aren’t particularly concerned about economic stability. Their driving factor is Jihadism. We’ve heard their ideologues stating that even if they were to incur losses among their own societies in order to defeat the infidel powers, then let it be.

Ten percent losses in local companies and markets are a price that radicals would absorb if the final prize is an earth-shattering change in US policy in the region and a triumphant return to pre-9/11 status. I find the rationale of this policy very Jihadist: if a world economic crisis is needed to remove the US democratization efforts from the region and to end its post 9/11 campaigns, the end justifies the means. In addition, how intriguing to see that Saudi Arabia and other producers are among the very few who didn’t have to pump much cash into their markets yet (Per news Agencies, today).

What some oil regimes -- or the ideological forces within -- want to accomplish from this alleged interference in US economics is to provoke a “regime change” in Washington, D.C., so that regimes in their region are not challenged anymore. But another issue is also coming to the surface: pressures against America’s financial structures seem to have escalated in parallel to increasing US talk and commitment to achieving energy independence. Since last April, the American debate finally reached a dramatic conclusion: “We’re sending 700 Billion Dollars a year to regimes that dislike us;” agree most national leaders; “and furthermore some of that money is ending up in the hands or accounts of Terrorists” affirm some among them.

This revolutionary conclusion is a direct affront to the multi-decades-long dominance of petro-dollars in US politics. What America is readying itself to do is to achieve its most dramatic war of independence since 1776: ending the dependence on Middle East Oil. Therefore, let’s not be surprised that these gigantic interests would strike at the heart of this economic revolution, as I coined it in my latest book, The Confrontation.

Back to the ongoing crisis on these shores, we nevertheless must admit that the original sins are domestic first: financial drunkenness and economic recklessness. Without these plagues, outside forces wouldn’t have been able to shake up America’s stability. But assuming that most capitalist societies travel through rough patches, it is vital to realize that America’s economy is under attack by forces aiming to maintain US dependency on foreign energy, as a means to obstruct the rise of democracy.

Seven years after 9/11, Americans are paying the price of liberty from their own economic flesh.

Dr Walid Phares, author of Future Jihad: Terrorist Strategies against America, of The war of Ideas: Jihadism against democracy and of the forthcoming book, The Confrontation. He is also the Director of the Future Terrorism Project at the Foundation for Defense of Democracies.

Another example of what a stupid leadership we have in this country and how we give it away is that the election is probably being influenced big time by foreigners. BO's campaign is flooded with donations from foreigners. How much is unclear but it is probably quite large. AS Bob Grant the radio host from NY would point out here is an article to this effect. He also asks that we contemplate why our enemies including Hamas and Hugo Chavez support BO? Do I need say more. Just like we *give* away citizenship to children born here of illegals we are giving foreing powers access to controlling our elections via small campaign donations that don't have to be reported. We already know Chinese are funneling tons of small donations through surrogates.God this country is going down the garbage can and even simple fixes can't get done due to politics, political correctness, and pandering for votes.

Foreign Money FLOODS Obama Campaign

Secret, Foreign Money Floods Into Obama Campaign

Monday, September 29, 2008 9:23 PM

By: Kenneth R. Timmerman Font Size

More than half of the whopping $426.9 million Barack Obama has raised has come from small donors whose names the Obama campaign won't disclose. And questions have arisen about millions more in foreign donations the Obama campaign has received that apparently have not been vetted as legitimate. Obama has raised nearly twice that of John McCain's campaign, according to new campaign finance report. But because of Obama's high expenses during the hotly contested Democratic primary season and an early decision to forgo public campaign money and the spending limits it imposes, all that cash has not translated into a financial advantage - at least, not yet. The Obama campaign and the Democratic National Committee began September with $95 million in cash, according to reports filed with the Federal Election Commission (FEC). The McCain camp and the Republican National Committee had $94 million, because of an influx of $84 million in public money. But Obama easily could outpace McCain by $50 million to $100 million or more in new donations before Election Day, thanks to a legion of small contributors whose names and addresses have been kept secret. Unlike the McCain campaign, which has made its complete donor database available online, the Obama campaign has not identified donors for nearly half the amount he has raised, according to the Center for Responsive Politics (CRP). Federal law does not require the campaigns to identify donors who give less than $200 during the election cycle. However, it does require that campaigns calculate running totals for each donor and report them once they go beyond the $200 mark. Surprisingly, the great majority of Obama donors never break the $200 threshold. "Contributions that come under $200 aggregated per person are not listed," said Bob Biersack, a spokesman for the FEC. "They don't appear anywhere, so there's no way of knowing who they are. "

The FEC breakdown of the Obama campaign has identified a staggering $222.7 million as coming from contributions of $200 or less. Only $39.6 million of that amount comes from donors the Obama campaign has identified. It is the largest pool of unidentified money that has ever flooded into the U.S. election system, before or after the McCain-Feingold campaign finance reforms of 2002. Biersack would not comment on whether the FEC was investigating the huge amount of cash that has come into Obama's coffers with no public reporting. But Massie Ritsch, a spokesman for CRP, a campaign-finance watchdog group, dismissed the scale of the unreported money. "We feel comfortable that it isn't the $20 donations that are corrupting a campaign," he told Newsmax. But those small donations have added up to more than $200 million, all of it from unknown and unreported donors. Ritsch acknowledges that there is skepticism about all the unreported money, especially in the Obama campaign coffers. "We and seven other watchdog groups asked both campaigns for more information on small donors," he said. "The Obama campaign never responded," whereas the McCain campaign "makes all its donor information, including the small donors, available online. "

The rise of the Internet as a campaign funding tool raises new questions about the adequacy of FEC requirements on disclosure. In pre-Internet fundraising, almost all political donations, even small ones, were made by bank check, leaving a paper trail and limiting the amount of fraud. But credit cards used to make donations on the Internet have allowed for far more abuse. "While FEC practice is to do a post-election review of all presidential campaigns, given their sluggish metabolism, results can take three or four years," said Ken Boehm, the chairman of the conservative National Legal and Policy Center. Already, the FEC has noted unusual patterns in Obama campaign donations among donors who have been disclosed because they have gone beyond the $200 minimum. FEC and Mr. Doodad Pro

When FEC auditors have questions about contributions, they send letters to the campaign's finance committee requesting additional information, such as the complete address or employment status of the donor. Many of the FEC letters that Newsmax reviewed instructed the Obama campaign to "redesignate" contributions in excess of the finance limits. Under campaign finance laws, an individual can donate $2,300 to a candidate for federal office in both the primary and general election, for a total of $4,600. If a donor has topped the limit in the primary, the campaign can "redesignate" the contribution to the general election on its books. In a letter dated June 25, 2008, the FEC asked the Obama campaign to verify a series of $25 donations from a contributor identified as "Will, Good" from Austin, Texas. Mr. Good Will listed his employer as "Loving" and his profession as "You. "

A Newsmax analysis of the 1.4 million individual contributions in the latest master file for the Obama campaign discovered 1,000 separate entries for Mr. Good Will, most of them for $25. In total, Mr. Good Will gave $17,375. Following this and subsequent FEC requests, campaign records show that 330 contributions from Mr. Good Will were credited back to a credit card. But the most recent report, filed on Sept. 20, showed a net cumulative balance of $8,950 - still well over the $4,600 limit. There can be no doubt that the Obama campaign noticed these contributions, since Obama's Sept. 20 report specified that Good Will's cumulative contributions since the beginning of the campaign were $9,375. In an e-mailed response to a query from Newsmax, Obama campaign spokesman Ben LaBolt pledged that the campaign would return the donations. But given the slowness with which the campaign has responded to earlier FEC queries, there's no guarantee that the money will be returned before the Nov. 4 election. Similarly, a donor identified as "Pro, Doodad," from "Nando, NY," gave $19,500 in 786 separate donations, most of them for $25. For most of these donations, Mr. Doodad Pro listed his employer as "Loving" and his profession as "You," just as Good Will had done. But in some of them, he didn't even go this far, apparently picking letters at random to fill in the blanks on the credit card donation form. In these cases, he said he was employed by "VCX" and that his profession was "VCVC. "

Following FEC requests, the Obama campaign began refunding money to Doodad Pro in February 2008. In all, about $8,425 was charged back to a credit card. But that still left a net total of $11,165 as of Sept. 20, way over the individual limit of $4,600. Here again, LaBolt pledged that the contributions would be returned but gave no date. In February, after just 93 donations, Doodad Pro had already gone over the $2,300 limit for the primary. He was over the $4,600 limit for the general election one month later. In response to FEC complaints, the Obama campaign began refunding money to Doodad Pro even before he reached these limits. But his credit card was the gift that kept on giving. His most recent un-refunded contributions were on July 7, when he made 14 separate donations, apparently by credit card, of $25 each. Just as with Mr. Good Will, there can be no doubt that the Obama campaign noticed the contributions, since its Sept. 20 report specified that Doodad's cumulative contributions since the beginning of the campaign were $10,965. Foreign Donations

And then there are the overseas donations - at least, the ones that we know about. The FEC has compiled a separate database of potentially questionable overseas donations that contains more than 11,500 contributions totaling $33.8 million. More than 520 listed their "state" as "IR," often an abbreviation for Iran. Another 63 listed it as "UK," the United Kingdom. More than 1,400 of the overseas entries clearly were U.S. diplomats or military personnel, who gave an APO address overseas. Their total contributions came to just $201,680. But others came from places as far afield as Abu Dhabi, Addis Ababa, Beijing, Fallujah, Florence, Italy, and a wide selection of towns and cities in France. Until recently, the Obama Web site allowed a contributor to select the country where he resided from the entire membership of the United Nations, including such friendly places as North Korea and the Islamic Republic of Iran. Unlike McCain's or Sen. Hillary Clinton's online donation pages, the Obama site did not ask for proof of citizenship until just recently. Clinton's presidential campaign required U.S. citizens living abroad to actually fax a copy of their passport before a donation would be accepted. With such lax vetting of foreign contributions, the Obama campaign may have indirectly contributed to questionable fundraising by foreigners. In July and August, the head of the Nigeria's stock market held a series of pro-Obama fundraisers in Lagos, Nigeria's largest city. The events attracted local Nigerian business owners. At one event, a table for eight at one fundraising dinner went for $16,800. Nigerian press reports claimed sponsors raked in an estimated $900,000. The sponsors said the fundraisers were held to help Nigerians attend the Democratic convention in Denver. But the Nigerian press expressed skepticism of that claim, and the Nigerian public anti-fraud commission is now investigating the matter. Concerns about foreign fundraising have been raised by other anecdotal accounts of illegal activities. In June, Libyan leader Moammar Gadhafi gave a public speech praising Obama, claiming foreign nationals were donating to his campaign. "All the people in the Arab and Islamic world and in Africa applauded this man," the Libyan leader said. "They welcomed him and prayed for him and for his success, and they may have even been involved in legitimate contribution campaigns to enable him to win the American presidency..."

Though Gadhafi asserted that fundraising from Arab and African nations were "legitimate," the fact is that U.S. federal law bans any foreigner from donating to a U.S. election campaign. The rise of the Internet and use of credit cards have made it easier for foreign nationals to donate to American campaigns, especially if they claim their donation is less than $200. Campaign spokesman LaBolt cited several measures that the campaign has adopted to "root out fraud," including a requirement that anyone attending an Obama fundraising event overseas present a valid U.S. passport, and a new requirement that overseas contributors must provide a passport number when donating online. One new measure that might not appear obvious at first could be frustrating to foreigners wanting to buy campaign paraphernalia such as T-shirts or bumper stickers through the online store. In response to an investigation conducted by blogger Pamela Geller, who runs the blog Atlas Shrugs, the Obama campaign has locked down the store. Geller first revealed on July 31 that donors from the Gaza strip had contributed $33,000 to the Obama campaign through bulk purchases of T-shirts they had shipped to Gaza. The online campaign store allows buyers to complete their purchases by making an additional donation to the Obama campaign. A pair of Palestinian brothers named Hosam and Monir Edwan contributed more than $31,300 to the Obama campaign in October and November 2007, FEC records show. Their largesse attracted the attention of the FEC almost immediately. In an April 15, 2008, report that examined the Obama campaign's year-end figures for 2007, the FEC asked that some of these contributions be reassigned. The Obama camp complied sluggishly, prompting a more detailed admonishment form the FEC on July 30. The Edwan brothers listed their address as "GA," as in Georgia, although they entered "Gaza" or "Rafah Refugee camp" as their city of residence on most of the online contribution forms. According to the Obama campaign, they wrongly identified themselves as U.S. citizens, via a voluntary check-off box at the time the donations were made. Many of the Edwan brothers' contributions have been purged from the FEC database, but they still can be found in archived versions available for CRP and other watchdog groups. The latest Obama campaign filing shows that $891.11 still has not been refunded to the Edwan brothers, despite repeated FEC warnings and campaign claims that all the money was refunded in December. A Newsmax review of the Obama campaign finance filings found that the FEC had asked for the redesignation or refund of 53,828 donations, totaling just under $30 million. But none involves the donors who never appear in the Obama campaign reports, which the CRP estimates at nearly half the $426.8 million the Obama campaign has raised to date. Many of the small donors participated in online "matching" programs, which allows them to hook up with other Obama supporters and eventually share e-mail addresses and blogs. The Obama Web site described the matching contribution program as similar to a public radio fundraising drive. "Our goal is to bring 50,000 new donors into our movement by Friday at midnight," campaign manager David Plouffe e-mailed supporters on Sept. 15. "And if you make your first online donation today, your gift will go twice as far. A previous donor has promised to match every dollar you donate. "

FEC spokesman Biersack said he was unfamiliar with the matching donation drive. But he said that if donations from another donor were going to be reassigned to a new donor, as the campaign suggested, "the two people must agree" to do so. This type of matching drive probably would be legal as long as the matching donor had not exceeded the $2,300 per-election limit, he said. Obama campaign spokesman LaBolt said, "We have more than 2.5 million donors overall, hundreds of thousands of which have participated in this program. "

CCP: "I just don't think simply saying we need to cut taxes is enough with BO out there preaching his lies for months with "I am cutting taxes for 90% of the folks in this country". ...The BO campaign has done a MUCH better job of responding to and countering the Repubs arguments than the other way around."

- Very true. Barack in his campaign is slick and slippery. His rhetoric doesn't at all match his record. If I were a centrist watching this only through mainstream sources I would probably join Obama and fight for hope and change. McCain should have set up a Bill Clinton style war room from the start and he should have gone ballistic immediately over Democrats blocking reforms on Fannie Mae and Freddie Mac. Instead voters think McCain and deregulation brought down the house. Remarkably, most voters think they will face lower tax rates if Democrats take full control all branches of government. The way things are going, I wish that were true .---CCP:"McCain either better have a great case to squash the "I am going to cut taxes for 90%", and "what has been done for the last eight years is not working" arguments in this last debate or it is definitely over."

True, he just can't undo later what was allowed to stand for so long as unchallenged fact.

This week allegedly McCain will unveil a 'new' economic plan. Even if he gets it perfectly right economically, he can only be perceived as a) pandering, b) desperate, c) unsteady in his leadership and d) irresponsible to the deficit and future generations.

My wish was to have an honest and consistent liberal run against an honest and consistent conservative and have them each strenuously argue their case to the people. Instead we have confusion-economics on both sides selling to a confused electorate.---CCP: "Are there more small business owners than government employees, union people, and immigrants who come in a jump on the dole bandwagon (of course not all of them - but enough)? I doubt it. McCain is preaching to the minority. BO is preaching to the majority. End of story."

- You are obviously right in terms of numbers of voters. The counterpoint is that hurting your employer or taking down ANY major sector of our economy will hurt you and your family no matter who you are. Workers and even welfare recipients share the economy with investment capital, investors and business owners. My union friends who worked for Northwest airlines, like the GM workers in Michael Moore's movie, always had an 'us versus them', worker versus ownership attitude. Bringing down those businesses and damaging those investments wasn't helpful to those jobs. Same goes for the current market collapse. Someone needs to articulate win-win choices to counter the us versus them, class envy politics. McCain hasn't done that.

There is no narrative that runs through the McCain campaign. The economy should be America's biggest strength and whoever is the Republican nominee should be out front leading the charge. Instead, McCain is that hoping unknown events in the next 23 days will change the subject.

The 1% Panic Our financial models were only meant to work 99% of the time.By L. GORDON CROVITZ

The Panic of 2008 is a crisis of trust. Investors don't trust the value of bad debts enough to offer market-clearing prices. Banks don't trust one another to stay in business long enough to do business together. And there's definitely no trust that Washington can avoid creating costly new moral hazards as it attempts to bail out the system.

But the most paralyzing loss of trust may be in Wall Street's system itself: How did the smartest people at the best banks running the most sophisticated financial models fail to forecast the collapse of mortgage-related securities? How did this unpredicted collapse devastate the system? And most of all, can we ever again trust the financial models on which value is supposed to be determined?

These questions matter because despite the current crisis, modern finance has delivered enormous benefits, from explaining to investors why they should diversify their investments to the creation of mutual and index funds. Related innovations helped financial institutions speed capital to its best use, fund new businesses and accelerate global prosperity. In other words, financial engineering worked beautifully -- until suddenly it didn't.

So what happened? Financial models take logic and historical data into account, but it's now clear that these elegant models have a serious weakness: They can't cope with illogical and uneconomic factors. Washington's insistence for years on artificial subsidies for mortgages through Freddie Mac, Fannie Mae and other programs led to a loud "Does not compute!" that is still rocking the financial system.

Here's how ill-conceived regulation poisoned the system. Until recently, bank CEOs and regulators slept well at night thanks to a financial model developed in the 1990s called "value at risk" or VaR. It assesses historical variances and covariances among different securities, informing financial institutions of the risks they're taking. By assessing risk factors across all securities, VaR can compare historical levels of risk for given portfolios, usually up to a 99% probability that banks would not lose more than a certain amount of money. In normal times, banks compare the VaR worst case with their capital to make sure their reserves can cover losses.

But VaR can't account for extreme unprecedented events -- the collapse of Barings in 1995 due to a rogue trader in Singapore, or today's government-mandated bad mortgages bundled into securities that are hard to value and unwind. The "1% likely" happened. And because the 1% literally didn't compute, there was no estimate of the stunning losses that have occurred.

Yale mathematician Benoit Mandelbrot pointed out the shortcomings of the VaR model in his "The (Mis)behavior of Markets," published in 2004. He noted that bell curves work for, say, disparities in the height of people. In markets, instead of flat tails of rare events at either end of the bell curve, there are "fat tails" of huge upsides and huge downsides. Markets are more complex than the neat shape of bell curves.

Last year's bestselling nonfiction book had a similar theme. In "The Black Swan," former trader Nassim Nicholas Taleb pointed out that extreme outcomes are actually common, warning that financial engineers -- "scientists," as he calls them -- ignore these unlikely outcomes at their peril. But today's credit panic was not entirely unpredictable. Mr. Taleb was prescient in writing, "The government-sponsored institution Fannie Mae, when I look at their risks, seems to be sitting on a barrel of dynamite, vulnerable to the slightest hiccup. But not to worry: Their large staffs of scientists deemed these events 'unlikely.'"

Likewise, the financial engineers at once high-flying hedge fund Long-Term Capital Management thought they had taken all risks into account, but the Russian financial crisis of 1998 blew their model. Last week the former general counsel of LTCM, James Rickards, reflected on how an incomplete VaR model undermined his firm. "Since we have scaled the system to unprecedented size, we should expect catastrophes of unprecedented size as well," he wrote in the Washington Post. "We're in the middle of one such catastrophe, and complexity theory says it will get much worse."

Global markets and new financial instruments are indeed complex. This complexity led to a fragility that made government meddling in markets more dangerous than ever before -- creating the 1% likely disaster. The good news for VaR and similar models is that the free market alone would not have allowed the bubble of subsidized mortgages, but the bad news is that it's far from clear that Congress has learned from the current crisis to pursue policy goals in ways that don't distort the fundamentals of markets.

Now the regulators trying to fix the damage in the financial system must also try to avoid more 1% likely crises. Transparent steps that restore market efficiency are better than complex, ad hoc policies that postpone market solutions. These programs should be judged on whether they make the financial models function better or function not at all. As we've learned, there's not much room in between.

Bernanke Is Fighting the Last War 'Everything works much better when wrong decisions are punished and good decisions make you rich.'By BRIAN M. CARNEY

WSJNew York

On Aug. 9, 2007, central banks around the world first intervened to stanch what has become a massive credit crunch.

Since then, the Federal Reserve and the Treasury have taken a series of increasingly drastic emergency actions to get lending flowing again. The central bank has lent out hundreds of billions of dollars, accepted collateral that in the past it would never have touched, and opened direct lending to institutions that have never had that privilege. The Treasury has deployed billions more. And yet, "Nothing," Anna Schwartz says, "seems to have quieted the fears of either the investors in the securities markets or the lenders and would-be borrowers in the credit market."

Randy JonesThe credit markets remain frozen, the stock market continues to get hammered, and deep recession now seems a certainty -- if not a reality already.

Most people now living have never seen a credit crunch like the one we are currently enduring. Ms. Schwartz, 92 years old, is one of the exceptions. She's not only old enough to remember the period from 1929 to 1933, she may know more about monetary history and banking than anyone alive. She co-authored, with Milton Friedman, "A Monetary History of the United States" (1963). It's the definitive account of how misguided monetary policy turned the stock-market crash of 1929 into the Great Depression.

Since 1941, Ms. Schwartz has reported for work at the National Bureau of Economic Research in New York, where we met Thursday morning for an interview. She is currently using a wheelchair after a recent fall and laments her "many infirmities," but those are all physical; her mind is as sharp as ever. She speaks with passion and just a hint of resignation about the current financial situation. And looking at how the authorities have handled it so far, she doesn't like what she sees.

Federal Reserve Chairman Ben Bernanke has called the 888-page "Monetary History" "the leading and most persuasive explanation of the worst economic disaster in American history." Ms. Schwartz thinks that our central bankers and our Treasury Department are getting it wrong again.

To understand why, one first has to understand the nature of the current "credit market disturbance," as Ms. Schwartz delicately calls it. We now hear almost every day that banks will not lend to each other, or will do so only at punitive interest rates. Credit spreads -- the difference between what it costs the government to borrow and what private-sector borrowers must pay -- are at historic highs.

This is not due to a lack of money available to lend, Ms. Schwartz says, but to a lack of faith in the ability of borrowers to repay their debts. "The Fed," she argues, "has gone about as if the problem is a shortage of liquidity. That is not the basic problem. The basic problem for the markets is that [uncertainty] that the balance sheets of financial firms are credible."

So even though the Fed has flooded the credit markets with cash, spreads haven't budged because banks don't know who is still solvent and who is not. This uncertainty, says Ms. Schwartz, is "the basic problem in the credit market. Lending freezes up when lenders are uncertain that would-be borrowers have the resources to repay them. So to assume that the whole problem is inadequate liquidity bypasses the real issue."

In the 1930s, as Ms. Schwartz and Mr. Friedman argued in "A Monetary History," the country and the Federal Reserve were faced with a liquidity crisis in the banking sector. As banks failed, depositors became alarmed that they'd lose their money if their bank, too, failed. So bank runs began, and these became self-reinforcing: "If the borrowers hadn't withdrawn cash, they [the banks] would have been in good shape. But the Fed just sat by and did nothing, so bank after bank failed. And that only motivated depositors to withdraw funds from banks that were not in distress," deepening the crisis and causing still more failures.

But "that's not what's going on in the market now," Ms. Schwartz says. Today, the banks have a problem on the asset side of their ledgers -- "all these exotic securities that the market does not know how to value."

"Why are they 'toxic'?" Ms. Schwartz asks. "They're toxic because you cannot sell them, you don't know what they're worth, your balance sheet is not credible and the whole market freezes up. We don't know whom to lend to because we don't know who is sound. So if you could get rid of them, that would be an improvement." The only way to "get rid of them" is to sell them, which is why Ms. Schwartz thought that Treasury Secretary Hank Paulson's original proposal to buy these assets from the banks was "a step in the right direction."

The problem with that idea was, and is, how to price "toxic" assets that nobody wants. And lurking beneath that problem is another, stickier problem: If they are priced at current market levels, selling them would be a recipe for instant insolvency at many institutions. The fears that are locking up the credit markets would be realized, and a number of banks would probably fail.

Ms. Schwartz won't say so, but this is the dirty little secret that led Secretary Paulson to shift from buying bank assets to recapitalizing them directly, as the Treasury did this week. But in doing so, he's shifted from trying to save the banking system to trying to save banks. These are not, Ms. Schwartz argues, the same thing. In fact, by keeping otherwise insolvent banks afloat, the Federal Reserve and the Treasury have actually prolonged the crisis. "They should not be recapitalizing firms that should be shut down."

Rather, "firms that made wrong decisions should fail," she says bluntly. "You shouldn't rescue them. And once that's established as a principle, I think the market recognizes that it makes sense. Everything works much better when wrong decisions are punished and good decisions make you rich." The trouble is, "that's not the way the world has been going in recent years."

Instead, we've been hearing for most of the past year about "systemic risk" -- the notion that allowing one firm to fail will cause a cascade that will take down otherwise healthy companies in its wake.

Ms. Schwartz doesn't buy it. "It's very easy when you're a market participant," she notes with a smile, "to claim that you shouldn't shut down a firm that's in really bad straits because everybody else who has lent to it will be injured. Well, if they lent to a firm that they knew was pretty rocky, that's their responsibility. And if they have to be denied repayment of their loans, well, they wished it on themselves. The [government] doesn't have to save them, just as it didn't save the stockholders and the employees of Bear Stearns. Why should they be worried about the creditors? Creditors are no more worthy of being rescued than ordinary people, who are really innocent of what's been going on."

It takes real guts to let a large, powerful institution go down. But the alternative -- the current credit freeze -- is worse, Ms. Schwartz argues.

"I think if you have some principles and know what you're doing, the market responds. They see that you have some structure to your actions, that it isn't just ad hoc -- you'll do this today but you'll do something different tomorrow. And the market respects people in supervisory positions who seem to be on top of what's going on. So I think if you're tough about firms that have invested unwisely, the market won't blame you. They'll say, 'Well, yeah, it's your fault. You did this. Nobody else told you to do it. Why should we be saving you at this point if you're stuck with assets you can't sell and liabilities you can't pay off?'" But when the authorities finally got around to letting Lehman Brothers fail, it had saved so many others already that the markets didn't know how to react. Instead of looking principled, the authorities looked erratic and inconstant.

How did we get into this mess in the first place? As in the 1920s, the current "disturbance" started with a "mania." But manias always have a cause. "If you investigate individually the manias that the market has so dubbed over the years, in every case, it was expansive monetary policy that generated the boom in an asset.

"The particular asset varied from one boom to another. But the basic underlying propagator was too-easy monetary policy and too-low interest rates that induced ordinary people to say, well, it's so cheap to acquire whatever is the object of desire in an asset boom, and go ahead and acquire that object. And then of course if monetary policy tightens, the boom collapses."

The house-price boom began with the very low interest rates in the early years of this decade under former Fed Chairman Alan Greenspan.

"Now, Alan Greenspan has issued an epilogue to his memoir, 'Time of Turbulence,' and it's about what's going on in the credit market," Ms. Schwartz says. "And he says, 'Well, it's true that monetary policy was expansive. But there was nothing that a central bank could do in those circumstances. The market would have been very much displeased, if the Fed had tightened and crushed the boom. They would have felt that it wasn't just the boom in the assets that was being terminated.'" In other words, Mr. Greenspan "absolves himself. There was no way you could really terminate the boom because you'd be doing collateral damage to areas of the economy that you don't really want to damage."

Ms Schwartz adds, gently, "I don't think that that's an adequate kind of response to those who argue that absent accommodative monetary policy, you would not have had this asset-price boom." Policies based on such thinking only lead to a more damaging bust when the mania ends, as they all do. "In general, it's easier for a central bank to be accommodative, to be loose, to be promoting conditions that make everybody feel that things are going well."

Fed Chairman Ben Bernanke, of all people, should understand this, Ms. Schwartz says. In 2002, Mr. Bernanke, then a Federal Reserve Board governor, said in a speech in honor of Mr. Friedman's 90th birthday, "I would like to say to Milton and Anna: Regarding the Great Depression. You're right, we did it. We're very sorry. But thanks to you, we won't do it again."

"This was [his] claim to be worthy of running the Fed," she says. He was "familiar with history. He knew what had been done." But perhaps this is actually Mr. Bernanke's biggest problem. Today's crisis isn't a replay of the problem in the 1930s, but our central bankers have responded by using the tools they should have used then. They are fighting the last war. The result, she argues, has been failure. "I don't see that they've achieved what they should have been trying to achieve. So my verdict on this present Fed leadership is that they have not really done their job."